Ep. 46 Mike Philbrick and Rodrigo Gordillo, Resolve Asset Management

Our conversation with Resolve Asset Management's Mike Philbrick and Rodrigo Gordillo. We discuss how in little more than 10 weeks we have gone from "What's going on with the market? The world is ending." to "What's going on with the market? Why isn't the world ending?"

Investors have a second chance now in the midst of the COVID-19 shutdown shock, the biggest single economic event of our lifetimes, to revisit their portfolio construction, and to reconstruct their portfolios so as to capture the highest realized risk adjusted returns, and all but eliminate their exposure to 4-standard deviation, black swan type market events.

Originally recorded May 26, 2020

Also available on Apple Podcasts, Google Podcasts, or wherever you get your favourite podcasts.

Full Transcript

Pierre Daillie: [00:00:00] Hello, and welcome to the Insight is Capital Podcast. My name is Pierre Daillie, Managing Editor of AdvisorAnalyst.com. Our guests today are Rodrigo Gordillo and Mike Philbrick from Resolve Asset Management. Rodrigo and Mike, along with Adam Butler, are co founders and portfolio managers at Resolve Asset Management, for the Resolve Adaptive Asset Allocation Fund and Horizons Global Risk Parity ETF (Ticker: HRA), as well as Resolve's managed accounts.

Prior to co-founding Resolve Asset Management in 2015, they were portfolio managers at Dundee Private Wealth, Richardson GMP, and Macquarie Private Wealth. They are also the co-authors of their book, Adaptive Asset Allocation: Dynamic Global Portfolios to Profit in Good Times - and Bad, published by Wiley.

Gentlemen it's great to have you welcome to the show.

Rodrigo Gordillo: [00:00:50] Pierre, always a pleasure

Pierre Daillie: [00:00:51] I'm curious to know what your clients, what's going on in your shop, what your clients are phoning in about what they're asking you, what are the most relevant conversations you're having?

One of them might be, you know, what the hell is going on with the market? It's just barreling ahead and you know, at the same time we're hearing about unemployment.

How do the two even come close to matching up in any sane kind of way when you have in the U.S. 40 million unemployed. Like, how does that translate into, into, you know, investors looking at the market and saying, let's buy 2023.

Mike Philbrick: [00:01:33] Right. It's so funny cause what you said is people are asking questions like, what's going on? And that has been actually the, the steady state question as what is going on has continually surprised people's expectations of what should be going on. Because if you, if you take this back to sort of mid, mid March, what's going on? The world is ending." – to today – "What's going on? Why isn't the world ending?"

Right? And with that, we've had, a disease, a virus caused a shock. A global shutdown, probably an economic event. that is probably the largest economic event of our lifetime. That causes a demand shock, that ripples through economies and that aggregate demand evisceration, also is being, complemented by supply line shocks.

And so you have this imbalance in aggregate demand and aggregate supply causing unemployment. Then you have massive coordinated central bank action on a monetary side as well as fiscal bank, fiscal government actions on the fiscal side, government actions on fiscal side to try and fill that hole, right?

And then the consequence of that hole is, is more debt. And we already had a debt problem and we already had slowing growth going into this particular pandemic. And so you're trying to model. I really complex adaptive system that is going to have some consequences from. aggregate demand, sort of global economic shutdown, it's going to have, things that happen because of all this fiscal stimulus and you're trying to balance off, which is going to win and over what timeframe might that win.

So in the short term, you have fiscal stimulus and central banks. To me, that fills the hole, the gap. But that longterm debt is not a creative, that's, it becomes a claim on future growth and future earnings and future GDP earnings. And those longer term, you have this sort of. Ma, maybe potentially deflationary overhang.

And so the central banks have gone in and said, we will do anything required, which then begs the question of, well, if anything is required, what happened? And how bad could that be in, could, you know, monetary policy actually overcome that. So on top of that, you have massive uncertainty. When's the virus going to end? Will it end? What are the, what are the consequences and the iterations of it, you know, we're coming into the non flu season, so you're coming into the spring, summer season. Is it a coincidence that the viral load is lower and that the infection rates are less, you know, sort of deleterious to the human body?

Or is it because we're in a, you know, a higher, more sunshine, more outdoors, more vitamin D environment? We really don't, you know, there's a lot of that that's, I don't know

Rodrigo Gordillo: [00:04:17] What Mike has alluded to is all of the major, issues that are all competing for a voice and who's going to win out? How's the market gonna react? But your initial question was, what are clients asking about? What are they saying? And the answer is all of those things, right? So it's, there is no one voice that's saying.

Hey, the markets are terrible. Get me out. There's a number of clients that are like, we got to get back in. The market's gonna zoom. There's a number of clients saying that this is going to be worse than the great depression. Everybody talks about the shapes, right? The recovery.
You know, one, one individual told me about the, the Harry Potter recovery.

You know, the lightning bolt down.

Pierre Daillie: [00:05:00] Oh yeah.

Rodrigo Gordillo: [00:05:01] There's so many, so many recoveries. And the key thing that we like to highlight, this is kind of in our M.O. And w we've had discussions internally about this very strong opinions, very strong minded partners within Resolve that all had , different outcomes that they lean toward, right? And the conclusion that we always come to is that preparation here is key. This is what we communicate to advisor clients, to individual retail clients, institutional clients. When there is maximum uncertainty, the first default should be "Do no harm," right? If we really don't have an edge, if we really don't know, then you want to make sure that you're balanced across the different possible outcome.
And I know we've been on your podcast before. We talked about balance through global diversification, but. You know, this is one of the key things, and we knew upfront, if you had told me there was going to be a covert virus that was going to affect that globally, we could have told you upfront that the likely outcome would be sovereign bonds up, gold up, everything else down, right?

It's the structural reality behind asset classes. And so preparation is the most important thing. Do people have preparation in their portfolio. Do they have gold and sovereign bonds, German Bunds, UK guilts, treasury, us treasuries, Canadian government bonds in their portfolios in the right size in order to mitigate some of these big shots.

And. If it, if it's not that, let's say it's a, the government hyperextends itself and prints way too much money, right? Do they have commodities in their portfolios already? Not, not trying to predict, because this is a tough part right now. Right. But rather have it just in case it's hyperinflationary. Or if it's growth, maybe we solve all the problems.

Vaccine comes out, everybody goes out to work, and we have a massive growth. Do you have equities? Everybody has equities. So that one I'm not too worried about. I'm mostly worried. We are mostly worried about the rest. So you start with this idea of when clients come to you with all these differing opinions, what do you have to offer them?

And the first thing is, look enough arrows in our quiver to deal with all of it.

Pierre Daillie: [00:07:09] Diversification i mean in a word but not the way that most people imagine diversification or the way you imagine it i think

Rodrigo Gordillo: [00:07:17] It's curious. Pierre, What is divers...? What do you hear when people think of diversification?

Pierre Daillie: [00:07:21] 60% in equities, 40% in bonds or vice versa, 40% equity, 60% in bonds

Rodrigo Gordillo: [00:07:28] A hundred stocks. 80% of them in Canadian equities...

Pierre Daillie: [00:07:32] Well, that's, that's the tradition, right? That's the industry's tradition is the 60 40, but how many investors have alternatives in their portfolio? How many investors have, as we talked about in the past, how many investors have CTS or things that are truly, that have truly underperformed over the last decade? In order to prepare for the coming decades?

Mike Philbrick: [00:07:53] It's the behavioral. It's the natural compounding of the behavioral bias of you've got your home country bias. You've got your recency bias. You've got your overconfidence bias. , you know, you've got , all of these biases combined, to give you the portfolio that's rewarded you the most over the most recent period of time.

And then the reinforcement mechanism is that you do more of that and less of other things, which put you at a very precarious position when the regime finally shifts.

Pierre Daillie: [00:08:20] You guys are almost taking like a medical approach based on the way Rodrigo, you said. Do no harm first do no harm as the medical professionals oath. But unfortunately, you know, The way medications are prescribed often do more harm than good. And it would be nice if doctors took the same approach as you're proposing. It'd be nice if the industry in general took a more holistic approach to investment as well. In terms of owning or investing in things that are going to provide the ballast during equity downturns

Rodrigo Gordillo: [00:08:53] But, we have this problem , this issue with our business is that we are, we think we're paid to predict the future, to give advice, to tell them what's going to happen next. Right? That's not the case for everybody, but a lot of it has to do with research reports, analysis reports, and where do we think the market goes from here? And so on. And I kind of think we need to reframe all of this, right? That if we do take the Hippocratic oath from a, from an investment perspective.

That is the one piece of advice that we need to start with, and then we can start layering on a little bit of hubris, right? A little bit of predictive prediction, but if somebody comes to you when the markets are five times more volatile than they were for the last 10 years, right? And are telling you, where's the opportunity or where's the downside?

Should I buy, should I sell? The first response should be, we should actually just back away and diversify. I mean, hopefully. With the people that follow us and know our things. You, if you've been listening to the concept of risk parity and balance, we're already there. This wasn't a big event. You know, the risk parity strategy's had a 9% nine 10% drawdown. And you know, it's kind of a non event.

Pierre Daillie: [00:10:09] And how many people are in risk parity i mean like what percentage?

Rodrigo Gordillo: [00:10:13] Same amount of people that are in managed futures and the same amount of people that, that have tail protection...

Pierre Daillie: [00:10:19] Yeah most investors want to buy the winners right they want to buy what's winning they want to buy technology they want to buy perhaps healthcare

Rodrigo Gordillo: [00:10:25] What we've been advocating for years is that you need to start with, with a little more humility to the investment process and then start tilting towards a little bit of hubris.

Pierre Daillie: [00:10:35] You know, what I hear in our conversation is that most people just spend all of their time reacting. Right. Like okay. The stock market's down 35%. What do I do now? What if I, what if it keeps on going down? And then you know that's when investors capitulate and the ditch their stocks some or all and getting back in is going to be a nightmare It's a minefield really of mistakes, right? You're too late or, or you're, or you just never get back in. And so investors, I think who don't didn't have time to react or didn't react to this year's drawdown. They're doing wonderfully, uh, like they're happy that they didn't jump out of the market but those who were watching every day who were watching cnbc or bloomberg or whatever and reacting to what they were hearing the whole world's going to hell they got out so in a way the ones who benefit are the ones who aren't paying attention and the ones who

Mike Philbrick: [00:11:24] yeah, I would, I would add two words at the end of that. "So far."

Pierre Daillie: [00:11:29] Yeah exactly

Mike Philbrick: [00:11:30] You know, this game is long, like the road is long and there's going to be lots of ebb and flows.

Pierre Daillie: [00:11:36] I just wanted to continue on what Rodrigo, what you both been saying, which is that investment planning is about doing a lot of things that we don't necessarily care to do. Like exercising for health sake or eating well, eating real food, as opposed to eating a lot of processed food. Uh, investors are always looking for fast solutions to their investment problems. And they're rarely looking at what the longterm solutions are in terms of providing that smoother ride, as opposed to, you know, Jarring volatility

Mike Philbrick: [00:12:06] Yep. I mean, investors are humans. Humans want explainability and they want predictability. And the challenges that financial markets live on the edge between order, i.e., predictability and chaos, and they have moments of chaos interspersed in the regularity enough such that it disturbs the equilibrium enough where there's opportunities for people to make mistakes and for people to add excess value through other's mistakes. and that's part of the challenge of dealing in an environment that is dominated by power laws. You know, the market movements are not a function of normal distributions. And this is where you get into, well how, how might you, how might you attenuate that?

So what are the decisions you would make? So, so step one would be, as Rodrigo was alluding to, what's my 'know nothing portfolio,' what's the portfolio I would hold if I had no edge? I had no ability to make any kind of prediction about the future, what would that portfolio be? For us, it's risk parity and just because it's maximally diversified.

So whilst, you're taking advantage of harvesting all the risk premia that's out there, you also get all of the negative correlation through the risk premia and you balance that off so that, you know, the, the maniacs aren't running the asylum, so you get equal risk contribution from the various areas and readings.

That's it. That's one way to think about it. It's not the only way to think about it, but there's your, there's your 'no bet' portfolio. I don't know anything. So I would hold this portfolio. Now I want to overlay, as, as Rodrigo said, I want to inject some hubris. Well, you know, I wanna, I wanna employ some tactics that have a long history of proving out excess risk premia over the normal risk premia that might come, let's say the equity risk premium, you know, so I'm going to add some trend or momentum, carry, and so I'm going to get it a little bit of an excess return.

But before you do that, before you jump into the, into the tactics part, you really need to have a clear vision of what your no bet portfolio is. I think that's a, that's a step that most people skip and it's akin to, you know, a lot of people in this, in this pandemic have been doing puzzles, puzzles of being unpopular again, and so they dumped the pieces of the puzzle on the table.

And a lot of people start looking for the edges and the corners. That's okay, but you probably want to stand the cover, the box, the picture, up on the end of the table where you're, where you're building this puzzle so you have a good look at what the end vision is. Then you start to find the edges and the corners and put the puzzle together.

But without the picture on the front of the box, you're really foregoing a rather large potential opportunity for information. So. Start with your know nothing portfolio. Here's what I would own. You know, why do you extend duration? You expect to get higher returns from locking up your money for longer.

Why would you take the step from having safe money to having variability in your year-to-year returns? You would do that because you get an equity risk premia or a premium above and beyond that risk-free-rate. Oh, by the way, I think one of the things that has come as accepted is that the equity risk premia occurs like some sort of GIC investment, which is not true.

There are a 10 to 15 year periods where the equity risk premium is negative. And many of them in history, and we've come to this sort of, I call it maximum equity risk premium, where there's this maximum confidence in that the equity risk premium of whatever, four to 6% above the fixed rate fixed rate is like, it's like accepted as if it's going to come in like a dividend yield on a quarterly basis.

Rodrigo Gordillo: [00:15:42] What people don't understand or maybe they do understand and then just can't hold on to that understanding long enough to benefit from it. Is that. By choosing an asset class, whether you're a hundred percent bond portfolio investor that, in your retirement or a hundred percent equity investor when you're young, is that a hundred percent one or the other both lead to left fat tails in your distribution, right?

So everybody's talking to knows about the distribution and the fact that the four standard deviation events that should happen once every 10,000 years actually happen once every 10 years. Well, individually they do, but it turns out when you combine. The right amount of bonds, the right amount of equities and the right amount of commodities that fat tail gets way down.
You don't see a lot of, you don't see four standard deviation events almost, and you see a very small grouping of three standard deviation, negative events.

Pierre Daillie: [00:16:34] Rodrigo, I think it would be helpful actually, if just for a moment, for those of us who don't fully understand what a left fat tail event is, if you just took a moment just to explain it,

Rodrigo Gordillo: [00:16:43] It really is, if maybe people have heard about the, the example of, of The Black Swan, right? This is Nassim Taleb's concept of, you know, what we're used to seeing when we think about swans are white swans, right? And it is a very rare event that you see a Black Swan thing.

It is, it is extremely rare, right? So when we think about the bell curve in school, remember when everybody's. The Bell Curve is basically saying how many students have scored on average? And everybody hugs that average, right? You see kind of the tip of the bell, and there's a few fantastic outlier students on the right, and there's a few fantastic outliers on the left, but there are very few on both sides.

And this is what is known as a normal distribution is what we would expect to be equal on both ends. We in the market actually don't observe a normal distribution. the market acts a lot like a normal distribution for a long period of time. And then every five to 10 years, we see a massive blowup in volatility and a massive blow up to the downside in equities, right?

The 50, 40% drawdowns. For in between those 10 year periods, you see a lot of 10 to 15% drawdowns. Right? Perfectly normal in an older student. But then all of a sudden you have these massive events that create a really three, three deviations away from the average two to the negative side that shouldn't, you know, it doesn't feel like it should happen, but they happen.

And what that does from your retirement, from a retirement perspective, is it completely decimates it. Right. It completely decimates it. The example that Nassim uses is the idea of a turkey, right? A turkey, is fed every single day by its owner and the turkey, the smartest turkey starts to tally up the amount of days that this owner of theirs is feeding them.

And every day that passes by, they feel with more statistical significance that the owner cares about them more and more. Of course, this happened up until the day before Thanksgiving when, 'Whack' you get your head chopped off. Right? The problem with markets is that they lure you in, they lure you in, they lure you in, or any market, by the way, I just, I don't want to pinpoint one market.

It could be the bond market. It could be the gold market, it could be the equity market. The interesting thing is that this, you know, Thanksgiving for. equities, it happens at a different Thanksgiving for gold and happens at a different Thanksgiving day for bonds. They all blow up. They all get their head chopped off, but it happens at a different date and time. And so the goal is to understand that and understand how it can be absolutely detrimental to your savings to have a 40, 50% drawdown. That takes six years to recover and how important it is to have all of those arrows in your quiver so that you can, you can withstand these losses.

And when you put these things together, all of a sudden those really negative events don't happen, right? So risk parity threw away a 'bare. naive' risk parity lost 20%.

A 60/40 portfolio lost 37%. S&P 500 lost 55% right? So you need, the balance you need to have in a 20% is, you know, you need to make 30% of the break back to even, when you lose 50% you have to make a hundred percent to break back even.

So it's crucial to understand that the do no harm portfolio needs to be done upfront. The problem today is that people were asking the question, what do we do now in March 24th after a 30%, 35 in Canada, almost 40% drawdown. And at that point you can't say, "Fine. Balance." After you've lost that, right?

That point you have to say, well, you know, hopefully

Pierre Daillie: [00:20:14] You can react and you can rebalance, but how many investors are going to go for that on that day, where you say, you know, what all that's left to do right now is take some of that bond money and put it in equities. And then you're saying I made some money in my bonds, I lost 40% in equities. No way.

Rodrigo Gordillo: [00:20:30] Here's the beautiful thing about what just happened is that there was a much tougher conversation to have in March 24th as of like today, I think the NASDAQ is almost reaching its old highs. People have a Mulligan today.
Right , the horse was out of the barn for a while. Now it's back in the barn and we can now teach people and nudge people to toward preparation

Mike Philbrick: [00:20:53] Don't waste your Mulligan.

Pierre Daillie: [00:20:58] I love that. Sounds of the Mulligan.
I mean, it wasn't the pandemic, the fat tail event. I mean, it was totally unexpected. It was unforeseen, there was warnings, but obviously in the months leading up to it,

The fed won't allow it. I mean, it's, it's the fed the fed with the massive stimulus. The fed put. The fed won't allow investors to have come to live by that and adopt that as, as what the future's going to be from now on. And and where something's going to happen and to the economy or to the market. And if the bond market's going to seize, but it doesn't matter because the fed will be there and that's the problem isn't it hasn't that infected the psyche of investors ?

Mike Philbrick: [00:21:34] so, the moral hazard. So there's, there's a couple of different moral hazards actually. There's also the moral hazard that comes with, a central bank who regulates all banks centrally. Their moral hazard is that each time they're emboldened to do more and more and expected to do more and more, we succeed more and more power to them. And as they become more and more powerful. So it's not only moral hazard from the standpoint of the speculators in the market understanding that maybe there's a fed put, but there's a moral hazard at the central bank level from a monetarist's perspective of each time they do it, they seize more and more control, and the system relies more and more on them rather than a diverse outside influences for decisions.

And this starts to create the opportunity for more centralized planning, less entrepreneurism. So there's, there's a lot of things that get put to work here. Some of the way I think about that is there's, there's also the, when, right? So why was it February, March that the pandemic was perceived as being relevant and not before then?

Cause there were some mornings, it wasn't like it was totally hidden. In the great financial crisis. There were several moments prior to August where you could have had a collapse. I mean, you know, the Bear Stearns restructuring in, I think that was in sort of March. didn't cause the, the pile of sand. Here, we entered in a sort of chaos theory.

So , you have a level of instability, but you're not sure of what the event is that creates the cascading events that cause the problem. And so, that's where it's not really explainable. So , in retrospect, we're going to create a narrative that makes it seem as though it was a linear relationship between these stories of things that occurred that of course led to the great financial crisis, or of course led to the pandemic being the thing that caused the collapse and the unstable event to have a cascading event and then be able to be re-stabilized.

You just have to be careful there. I'm not saying your narrative is wrong or right. I'm just saying our human proclivity is that we're going to create a really good narrative to explain what happened, even though really we don't know what actually.

Rodrigo Gordillo: [00:23:50] Yeah, I totally agree with that. And it's one of those, one of these things where the narrative is that the fed has saved the world right now.

Right? So going back to trying to predict. Well, I don't know if anybody's ever examined a bear market before, but it doesn't happen in, in, in that month, right? Bear markets lasts a year to two years, and you have these massive losses. The Fed comes in, make sure he's a lender. Lender of last resort provides liquidity. Markets rebound on that euphoria.

And then we hit another flow and an ebb and a flow and an ebb. The idea of being able to have another second opportunity to be diversified in what we know to be bear markets that lasts a long time and that are sequential in their bulls and their bears and their bear market rallies is absolutely key here.

And what will happen over the next. Couple of weeks if we do have, we have hit a top and start going down, is that the Fed didn't have enough bullets, that there wasn't a coordinate enough coordination, that there's this nationalism and that that has been been bred by Trump and all the other nationalists that is, that is separating world powers and not allow for proper coordination and now that will become the dominant narrative, right.

That it was. That's an issue. The whole point of this is. What can you do that is, that is sustainable, where you don't have to put these massive bets in your portfolio. And the first one we talked about was balance, right? But then the other is understanding all these human traits, right? A lot of what you've already discussed in terms of individuals being making the wrong decisions at the wrong time.

These are behavioral flaws that are, that we see over and over again and are repetitive, right? This is known in the world of quantitative investing as trend following or momentum people tend to herd. Things that have recently gone down will continue to go down for a period. Things that have recently gone up will continue to go off for a period now. This is the thing that that has worked for. We have research going back 600 years, right? So humans will be humans. The question is whether you can now move away from your do no harm portfolio and start moving towards a little bit of prediction. Right. Using these factors and momentum and trend are just a couple from the macro perspective, you can use mean reversion, seasonality, carry, all of these different factors that now you can start tilting toward.

And of course, we also did an analysis on which one of these factors does best in these types of bear markets. We all had very strong opinions. Right? Mike pointed out in our early discussions that carry seems to be very procyclical. And so, you know, we might think about looking into the data and seeing if there's, you know, anything that, that maybe there's a way to follow up.

I'll use trend within carry or so on. and we found out that, and the thought from my perspective was a trend was probably going to be the best. And it turns out that carry was the best performer, right? I think a mean reversion was second then, then trend was third. And then when you examine all the other bear markets in history, you find that these different tilts, these factor tilts on the macro side are completely different, right? The common narrative on, on the equity factor, the value factor equities was that this is a time to shine. Everybody wanted to double down on value at the bottom here. Because value has done really, really well from the bottoms, right? You're basically grabbing all the junk that nobody wants.

Well, it turns out in this recovery, it's been the worst performer, right? So it really is tough to tell which, active tilt is going to do better. And we go, if we don't know which one's going to do better, we, what do we do? What can we tell our clients? What can we tell our advisor clients? Well, once again, you want to diversify across strategies, right?

Yeah. Go back to do no harm.

Mike Philbrick: [00:27:34] Don't just diversify across assets and strategies and whatnot. And that the challenge with looking at the bear markets and seeing what happened is that you have a very small handful of events from which you're going to make likely very spurious conclusions.

So something, something really wise that I read and it's credit to Josh Brown. what I read that was really wise was let's accept that we can't make sense of the economy versus the stock market. They're not really, I mean, it's hard to find a relationship, so let's, let's stop trying.

Mike Philbrick: [00:28:05] There's, there's lots of noise that shrouds that relationship.

Pierre Daillie: [00:28:08] What I mean, is let's let's stop. Let's stop spending so much time trying to make sense of that relationship. And do more of what we're actually talking about here. I think, I think it works both ways. You can't foresee. Yeah. You can't foresee what the fat tails are going to be um,

Mike Philbrick: [00:28:25] Here's what I think where you need to that. Investors need to understand . One of those ways in which you might do that or consider that as behavioral. Right? It is behavioral. Like what we talked about earlier, you won't want to rebalance when your bonds are up and your stock are down

Pierre Daillie: [00:28:38] That's actually the biggest risk there is. I mean, forget about what the unknowns are. The Howard marks letter on uncertainty really sort of opened my eyes as well. I don't know if you've seen it, but. I mean there was this laundry list of 26 questions, just about all of the unknown factors about the Corona virus.

Nevermind the market, you know, I don't want to go crazy on this, but, but just the fact that there was these 26 questions that have yet to be answered, just prove the point that uncertainty is something we just have to get used to.

Mike Philbrick: [00:29:09] Well, it's always here.

Pierre Daillie: [00:29:10] That's just, it, you, you can't be certain about anything

Mike Philbrick: [00:29:13] So this is, exactly what I'm referring to when I talk about markets walking the line between order and disorder, sort of predictability and chaos. They must walk that line enough to keep everybody on edge so that it provides the edge for others to achieve. There. There are winners and there are losers.

This is exactly , the scope with which you view the problem. So then the point isn't to feel hopeless. The point isn't to feel there's, there's no opportunity to address this. There are opportunities to address it, which we've talked about. Diversity, right? Diversity of the structural.

There are, we believe there are structural relationships between the economy and asset prices, and that's what that big market target is about and talks about inflationary and growth type shocks and those changes in those areas cause structural price movements in asset prices.

So we had a demand shock. We had a pandemic, both long-term government bonds and gold did exceptionally well in that they fulfilled their role in that, and equities did particularly poorly.

You had something killing it and you had something killing you. You had to hold them in the right amount of balance so that the portfolio could achieve the longterm risk premium.

If you did that through March. You had a 10% drawdown in your risk parity portfolio. That's a non-issue. That is those tails canceling each other out, and that's the max draw down to the day. So that was in the liquidity moment of, I think it was March 24th where we had a liquidity shock where those that were trying to exit markets were in such numbers that the system wasn't quite balancing off even bonds where you'd expect them to have been up a lot.

The off-the-run bonds weren't quite, you know, government bonds weren't quite participating in price. That was a day.

Rodrigo Gordillo: [00:31:08] That was a day maybe. It was two days in separate, but it was, yeah, it was those two things. The rest of the time, that risk parity approach was steady and. Yeah. It's never designed to not to have, it's not, it's not an absolute return strategy, right?
It's not designed to make you money across everything. It's designed to, to try to eliminate the 4-standard-deviation event and minimize the 3-standard-deviation events. And so it 10% correction is par for the course for any strategy. and, and the key is, and not if you're a retiree and you have to withdraw during that period.

That you're not withdrawing when your portfolio just went down 45% because you're reaching for yield. I mean, how many high yield funds blew up this this summer? And everybody who needs the money has been reaching for yield, has been a hundred with a hundred percent of the portfolio in that, and they needed to take out their monthly allowance.

Yeah. That is detrimental to retirement. So the key here is again, understanding from an, from a economic dynamic perspective, the, the growth and inflation dynamics in which asset classes thrive in those dynamics. And then understanding that those behavioral flaws that we identified, the trend that carry all of those are really tough to extract because people think, Oh, momentum is a thing and therefore I'm going to win every year.

It turns out the momentum, every bet that you make on momentum, every trade that you have, you're only right around 51, 52% of the time. It almost feels like a coin toss. And so the, if it were better than that. Then it would be carved out. It seems to be this like 51, 52% Mark where enough people give up that you're able to harvest that excess return over time.

Right. And the key is, and being disciplined about it. And then the key is, and like, look, momentum blows up. Momentum hits tails, which is a bad outcome, 10 times in a row sometimes. Does carry have 10 that that does have the same outcome as momentum at the same time?
No, they all blow up at different times.

Right. And if you want to be able to stick to that longterm premium, and by the way, we're talking about, you know, factors, what we could be talking about, any strategy that you have as an advisor looked into and liked and understood. And you have to understand that every one of your managers will blow up at a certain time.

Hopefully the process is diversified enough so that you can withstand that and stick to it, and that's the key part here, right? All of this is not about trying to predict where the market goes from here. It's about reemphasizing how important it is to have a plan upfront. And asset allocation, strategy, allocation, and, and then, you know, communication process for our clients.

And, and, and, and you're an individual, your investment policy statement that you should be doing for yourself if your advisor isn't doing it for you

Pierre Daillie: [00:33:56] and sticking to it and that's the point of the communications

Rodrigo Gordillo: [00:34:01] All those things, all those things should help you stick to it. We just have to cut that tether to the domestic market that people seem to think is important. It's not, it's not important.

Mike Philbrick: [00:34:16] And this, this is the challenge and behavioral challenges, not who your neighbors. Your neighbors in Houston are different than your neighbors in San Francisco or you know, Calgary, Alberta versus Toronto. And so you have, you have a different tracking error portfolio that your, your, your envy club is forcing you to keep up too, right?

So you can imagine you have this fully diversified, beautiful portfolio that's been ticking along. It. 6% a year. And you, you see, you're kind of happy with it until you talk to your buddy who's in the NASDAQ and he's in the 60/40 U S and he shows you all the research says, well, the U S is the largest economy in the world.

It's the only stock market unique cause it's globally diversified. And capitalism is the centerpiece there and will always be the centerpiece there. And thus you should just, you know, invest in the United States. Doesn't that make sense? You know, the answer there is, there's a lot of holes in that philosophy, but now you're under pressure.

Your, your beliefs are being attacked and they're just showing you performance is saying, look, here it is. You know, I'm better than you. And so there's, there's so many, behavioral vulnerabilities that, that, that you're, you need to be aware of that you didn't, you need to understand at a deep level so that you can overcome that envy and greed aspect of trying to keep up with your neighbors. And this is, this is really,

Pierre Daillie: [00:35:33] What's your strategy for getting your clients to think like rip van winkle

Mike Philbrick: [00:35:38] Yeah, we like to say we want to be in the hall of fame for realized risk adjusted returns.

So we want to give you good risk adjusted returns, but we want you to realize them. If you don't realize them, they're there and they're of no use to you and they're of no use to us. So we like to partner with, people who have the ability to read and understand our communications, have, are willing to do some work.

Because if you, if you're not willing to do some work to understand it, then you're just giving me some sort of blind faith or trust and inevitably a new guru is going to come along that's shinier and better. Rather, I'd rather, you know, we'll provide lots of information. We've talked about a lot of things on this podcast.

We're, we're active in digital media regularly because we want to make sure that you both. can understand you have the opportunity to understand and learn and understand why these prime drivers, these prime values are so important to longterm success. In the short term, the six, like you don't know, one month returns are totally random in the long term ten-year type, that's where you have the opportunity to garner excess return.

And most people don't ever look at their returns and say, well, how much risk did I take. They don't say, Oh, I've, I've had, you know, the return on for the last 20 years. For example, for long-term investors, a return on gold is better than the return on the S&P 500. Not too many people know that. That's because, the return in the last 10 years, since 2012 when gold peaked to today are zero.

And for the us equity market, they're extraordinary. And so it's the framing, it's the, it's so, so they, they, they just don't quite put those things together. So you want to be able to communicate those things to them, understanding that there's always going to be something killing it, always something going to be killing you.

But in order to be prepared, you need to have both because when the shock comes, no one rings a bell.

Rodrigo Gordillo: [00:37:30] No. And I, I just want to emphasize how important it is for those advisors listening that half the battle, if not more, is self-selection, right? Who are your clients? How did you filter your clients so that they will make your business thrive?

And the truth is that, you know, going out there and trying to convince people from scratch to doing it your way will inevitably meet the paler. What there was, we went to a content marketing, event. How long ago? Seven years ago, Mike, where I, we went to this, this speaker was talking about the silos between marketing and sales.

He was, he, he used to be a pool salesman, he used to sell pools, and, he would meet anybody and everybody who would want to buy a pool and spend his whole day running around the city doing it, and he would have 20% of that stick actually become clients. Then he started doing marketing and content marketing. He started putting brochures up.

He, he would, he decided at one point that he wasn't going to talk to anybody until they read his booklet, right? His full booklet as to what it is, and when he started doing that, then the vast majority of people didn't speak to them. He's going to waste his time. You continue to put out good content and good education.

By the time they, he allowed the prospective client to contact them, 80% of them would become clients. Right, right. And they were the right clients, that understood what he was offering. And so I think the interesting part for us is you asked us how many people were losing their minds. I don't know what you didn't say that, but how many advisors and clients were calling us?

You know, there were opinions, but nobody was freaking out. Everybody was on board. We had net inflows in our funds throughout this period. and we had the same thing in 2018 and October, 2018 when we had a bad drawdown. It was, it was just a Testament to finding the right clients and then constant education.

Right? So that's how you do it. It's not easy, and it means that you have to grow slower often in the beginning, especially because, it, , does mean you're gonna get less clients, but then you don't have those difficult clients. Right.

Pierre Daillie: [00:39:41] Yeah. Amazing. I think it, it has correct me if I'm wrong. I think first of all, I think risk parity is a subject or a term. It's a subject that's little understood. It sounds very technical. I think people get scared off by it because they think it's like a hedge fund.

And then of course the relationship there's the association to hedge funds, which is that it's risky. , and then what you get as a shutoff. So they look at risk parity, perf and then they look at risk parity, performance. If they even get that far and they see it has underperformed, the index is so right. So then there's also potentially a shut off, but I was really piqued by our last podcast where I actually learned something about capital efficiency, and that that term is also very technical. It sounds very, you know, it has all these terms have a mathematical element that is a little off putting. For, I think for most people potentially because it becomes almost a scientific uh, tilt in terms of trying to wrap your head around how things should be done.

I think when it comes to money, people are a bit reluctant advisers and investors are like a reluctant to give up what they think is control. And that is. Fleeting, what actually are you controlling? Nothing. You don't control the stock market. You don't control the bond market. All you control is your decisions. The thing that i think goes hand in hand with risk parity is capital efficiency .

Rodrigo Gordillo: [00:41:07] I think Canadians will resonate more with, with the idea of the Harry Brown permanent portfolio. I think maybe not everybody has heard that, but a lot of advisors it's the idea, it's that concept of, look, you need to have, things that Zig when other things based on different economic realities that we've seen over, over hundreds and hundreds of years. And so the, the original, that, the naive naive way of looking at this is for things you buy. You have 25% of your money in cash. 25% of your money in gold, 25 in sovereign bonds in 25% in equities, or you know, bond corporate bonds and equities, right? And so the bonds and equities will thrive in a growth environment that sovereign bonds will grow at a lower rate, but will thrive in a bear market in a deflationary environment like we've seen recently.

Gold will thrive in inflation, and cash will be there to, you know, protect against inflation as well, because it can actually. You do, it does a pretty good job and it also has some money that you can use to rebalance when equities have been cut in half. Right? That is the first attempt.

The problem with that approach is that you are, you were assuming that the volatility of each one of those quadrants is the same, but what happens if actual equities is five times more volatile than your bonds?

Right? What you'll find is that in that bear market. bonds will make money, but equities will lose five times more. And this is what we see in the 60 40 portfolio ? This so called a balanced portfolio in a way was down 37%. Is that balanced to you? Was it wouldn't balance be closer to the zero mark of not having lost money.

Pierre Daillie: [00:42:51] So That's interesting when you put it that way. I don't think people think of a balanced portfolio that way, you know, they still see a balanced portfolio as being perfectly it's perfectly as though it's perfectly acceptable to be unbalanced. That's a completely unbalanced portfolio

Rodrigo Gordillo: [00:43:07] When you look at when you put your risk parity goggles on, and there's a mathematical calculation and that calculation, I'm going to call them risk parity goggles.

Okay? Just trust me on it that it exists, but it can measure how much risk is contributed to a portfolio per asset class. And when you look at the 60/40 portfolio, people think that it's 60% equities, 40% bonds. But when you put your goggles on, you measure risk contribution. It turns out that on average you have 90% of the risk coming from equities and 10% of the risks coming from bonds.

What does that mean in a practical basis? Well, if I invest in that portfolio over the next 10 days, and over the next 10 days, equity lose money for 10 days and bonds make money for 10 days, your 60/40 portfolio will be dominated by equities and we'll lose nine out of those 10 days. So the direction is being pulled by the more volatile side of the portfolio.

Okay? Now let's grab that 60/40 and create a risk parity portfolio. What that would look like is you'd have most of your money in bonds, something like 80% in bonds, 20% in equities, and in that same ten-day period, you'll find that five times a five out of those 10 will. It will be random. It will be perfectly kind of flat, right?

There won't be one any day is being dominated by equities versus bonds. That means though, that you're going to have a higher weighting towards bonds then equities, and people see that and say. I want none of that. I need, I have a retirement to think of. I want to have the highest rate of return I possibly can.

And so what we accomplished by creating better balance is we've, we've actually reduced those left nasty tails right. We've reduced those three, four standard deviation events. Cause now we're in, we're truly in balance. S&P 500 drops, 50%. Your bonds should be able to make up most of that, which is what we've seen this year. And so you're not, you know, it's not a detriment to your retirement portfolio if you need to withdraw. But you, so what have you created for every unit of risk that you take? You've increased the, the unit of return. Your sharp ratio is also known, whereas a 60/40 portfolio tends to have a lower Sharpe ratio than a fixed income portfolio.

But because it's dominated by equities, your absolute return, because you're dominated by this volatility, your longterm expected risk premia is going to be, is expected to be higher from a 60/40 portfolio. so you have more balance and more stable outcomes for, for, for risk parity. but better absolute returns from equities, even though you're going to have to suffer these 37% drawdowns in the 60/40.

So how do you fix that? Well, the next, this is where we get to capital efficiency. by the way, I'm talking about bonds and equities, but risk parity also includes the inflation, the, the gold and the commodities in balance, in risk balance, right? So what you need to do now is you need to say, okay, well what if I can provide very, very cheap leverage?

And I, what you have in your risk parity portfolio is. Yeah. Half the volatility of 60/40 portfolio. What if I lever up the portfolio pro-rata until I match the volatility of my 60/40 or whatever risk profile you want. And it turns out that for every, if, if for every unit, let's say your 60/40 portfolio has a volatility of 10 and for every 10 units of risk that you take, the 60 40 portfolio gives you five units of return.

So you're getting 5% annual rate of return is 60/40 which has been kind of in line for a global balance portfolio. And let's say the risk parity before it gives you a 0.7 sharp meaning for 10 units of risk. If I can lever it up so I can hit 10% volatility, I am now getting seven units of return, not five.

Right? This leverage is what's called capital efficiency is the, the, the ability to use leverage in order to increase your returns, assuming a certain type of return and risk profile. It seems very complex, but the three things are balanced through asset allocation, making sure the maniacs aren't taken over the asylum, and then match the expected volatility of that portfolio to your risk parameters by using a little bit of leverage, or if you're super conservative.

Then in fact, add cash. This is a Nobel prize winning theorem of the capital market line, right? Right. See, efficient frontier with a tangency of the capital market line. Instead of buying more equities, which we all do, we actually use leverage your cash in order to hit a volatility profile, keep your sharp ratio and get better returns.

It is Nobel prize winning, but lo and behold, there is this behavioral flaw that we are also able to capture by doing this called an aversion to leverage, right. And so those are those who can and are willing to, you can get an excess risk premium by using leverage thoughtfully. And so that's, that's risk parity in a nutshell.

Anything you would add, Mike, that I may

Mike Philbrick: [00:47:51] No, that's capital efficiency as well. It's the same. It's, yeah, it's maximizing the diversification to get better risk adjusted returns. And, and this is the thing that's often missing when investors compare their returns over, various historical timelines.
They say, well, I made this return. Well, what, what risk did you take. Oh, I don't, I stuck with it. So the risk wasn't too much for me to handle, which is great, but we don't really know how many 20, 30, 40, 50% drawdowns that they encountered in order to get that return. Not too many people talk about the fact that Amazon had a three 90% drawdowns in order to get where it is today.
So you had to hold through three 90%. Drawdowns means it had to come back a thousand percent already for you to break even. And, You know, not, not everything that goes down, 90% comes back and most of it doesn't. The funny, the funny thing is, the best performing stock is Domino's pizza, so there you have it.

Rodrigo Gordillo: [00:48:49] Yeah. And look, this is, this goes back to the, this concept of like wanting to reach and reach for yield, reach for returns.

Cause that's what I need. Right? It's funny, the cognitive dissonance involved in, in most people's, most advisors minds, most people that I talked to is that you ask them, what do you actually think the long-term expected returns for a 60/40 portfolio are going like 20 or 30 years? What do you think you're gonna get.

And everybody comes back, it's like, well, yields are this, and equities are that at most after fees. We're probably looking at three, 4%. Right? So they know, like everybody says, that is is a, is a fact. We all understand it. And then we go through a 10 year period, and by the way, the sh, you know, the sharp ratio of equities historically is 0.3, right? But over the last 10 years, the sharp ratio of the S&P 500 is 0.8, the sharp ratio of the 60 40 portfolio because it's U.S. Equities and talking about mostly U.S. Investors, treasuries and equities having to be the best two performing. Asset classes on the planet, right?

So you have a 10 year period where this thing has just blown the lights out. It's in a 19 it was up until recently, the 99th percentile outcome of all historical sharp ratios, right? And so when you contrast that with a risk parity portfolio that owns global equities, global bonds, global currencies. Gold commodities and real estate people see that, as you mentioned earlier, it's this, they don't, they see the underperformance and they don't like it.

Well, it's under performance. It's under-performance. That has done four or 5% a year. The non-labor disparity, which is higher than what they themselves would expect the 10 years ago, 60/40 to do. But because of the vagrants of the year to year and this massive dispersion that can happen for long periods of time in a single asset class, everybody has abandoned the idea of diversification.
It's a tough thing to do, but all you need is one of these bear markets, and maybe this bear market leads back to that 50% drawn out over the next two years as the real economy starts to impact that. But the point is that it, when you're providing and risk parity. 4%, 5%, 6%, 2% negative, 3% positive, 7%, and S&P and the 60/40 is providing 18%, 15%, negative 5%, 10%, 12%, most years people feel really good about that portfolio.

Right? . Whereas most years they're going to feel really poorly about that low single digit portfolio of a non-levered risk parity. So that's another challenge of, of investing in diversified product like that. It's that you really need to think about this from the long-term perspective and match your expectations of returns with the actual outcome and not looking at the, the vagaries of your favorite market.

That is a, that is a real problem.

Pierre Daillie: [00:51:37] So let's get back. Let's go back for a moment back to the two points, stop trying to make sense of the economy and the stock market. And secondly, the Mulligan, since we've got this Mulligan and the second chance. What do you do now? Like, what is the, what is the way forward for the investor who has the Mulligan in hand?

I know you guys had a discussion the other day in a video about tail risks. You've got your equity money back or most of it. And you got a second chance. What do you do?

Mike Philbrick: [00:52:04] Well, I think first the first is an inward look to see, you know, what your, what's your, what's your human capital like versus your invested capital. So if you're 25 years of age and you've just started investing. You don't have to do anything. You actually hope for actually very poor investment returns out of equity so that you can buy more and more of them for some place down the road in 20 or 30 years, where you might start to harness those for some kind of income.

So really on the individual investor side, I think that has to be taking a new account. Now, let's, The reality of that question is that the majority of money is with those who have accumulated, whose human capital is depleted and his investment capital is what is what is going to give them a, an income stream over the next 20 years and so on a, on a money weighted basis.

That's the real question that, that really, I think needs to be addressed. And to my mind, it's, it's making sure that your risk is right for whatever your risk tolerances are. Based on what your expectancy for taking an income from this portfolio is. So there's a little bit of math behind that, what your return assumptions are, which would Rigo touched on.

But, but once you get through all of that, you say, okay, what should my portfolio construction look like? You know what my, what should my asset allocations look like? You'll probably find your return expectations are too high for a passive portfolio, and so you might want to skew more to equities now because you're like, well, the equities have the, you know, the best longterm return expectations.

The challenge is there. They're no longer cheap. They were cheap for a minute, and so you're stuck sitting in the middle again. And what if there's another 35% drawdown? So our thinking would be that you would want to layer on extra risk return premium. So you'd want to layer on those factor premium.

You'd want to make sure that you were considering all the various asset classes that could have positive returns in various regimes to harness those. You'd want to lay on top of those. Those carry factors of all factors, although the extra factor premia. And then probably have several strategies that do that.

And the great thing about doing that, if you look at tactical adaptive strategies that are thoughtful, like risk parody with factors. So we talked a lot about risk parody. Well we didn't touch on is the fact that you can add a ton of value to risk parity by layering on the factors, by layering on a trend and momentum factor and a carry factor, et cetera.

So you add those factors on top of those. And the great thing, now you've had this shock. And so most systematic portfolios have actually reduced the risk and exposure because they're doing that capital efficiency Rodrigo talked about, they're making sure the risk is right. If, if, if the volatility of assets is tremendous, your edge is smaller, definitionally your edge is smaller.

You don't know which way this thing's going to go, so you systematically reduce exposures. The nice thing is if you come into those. Calm those, those adaptive processes that are well-diversified. You're now coming into a portfolio that is somewhat conservative, but will grow exposures in the appropriate manner to follow on the trends and the carry and the factor to harness all of these things into the future.

So you're not sitting in cash. Totally. Uninvested. You're actually sitting in a very balanced portfolio. If I think about some of our own portfolios, they're very balanced between commodities. those non golden gold, bonds. They have still have some stocks from, you know, the NASDAQ and things, things that are working and things that have positive carry things that have seasonality.

And so you're getting into this portfolio. And then as things unfold. Every day, things are going to be monitored and looked at and rebalanced. And so as those trends unfold and as the price is realized, what's going to happen in central banks and what's going to happen with the virus and those trends sort of manifest, you're there every day.

And your money's putting, being put to work every day as the story evolves and the price moves first, and then the narrative evolves after. That's the way it happens. And so you'd be putting the money, money to work real time, and then at such time as things are normal and there's a bull market somewhere, let's say it's in gold in certain types of currencies, you've got money there, but then there'll be some sort of disruption in that area.

But then you'll be quick to react. Those adaptive strategies will be quick to react and to reduce the, the exposures again. So, you know, I have cash, what do I do with it now? Or I've been made whole again. What should I do now? These are some of the things that I would really think hard about. You talked about CTA strategies.

We have some of those, trend following strategy. These types of things need to be thought about as ways in which to start. Garnering exposure into the 60 40 because you've been given this Mulligan in this passive portfolio.

Rodrigo Gordillo: [00:56:56] Yeah. It just goes back to a previous podcast. We did that. What are you doing now?
It's time to get comfortable with being uncomfortable. Right. Discussion there. Yeah. The discussion there was, back then when we had that discussion about a year ago was, valuations are low, and by the way, I mean, bonds are. Yielding insanely small amount now, and we know that the 10 year correlation to current yield is high, so we know what you're going to get for your bond portfolio equities might've gotten a slightly better, but guess what? Nothing changed from last year. The evaluations are better outside of us and Canada. You got to get comfortable with being uncomfortable with buying global equities and global security.

Pierre Daillie: [00:57:44] Yeah that was the discussion that we had about Robert Shiller and investing in foreign markets .

Rodrigo Gordillo: [00:57:50] And now we also have at the forefront this looming inflation case, right?
This idea that we, what if we printed too much money here and then we have this massive growth and inflation gets away with that from us.

Well, now you got to hold gold and commodities to tips or how many, not many advisors, even known tips. Like you have to think about diversifying to that. So what you do now is you recognize that the, there are many outcomes here and you need to, you need to provide some returns.

So you need to go global. You need to be able to protect against tail events, not just growth tail, but inflation events. So you need to start allocating to alternative asset classes. And then once you have that built. Find strategies that are trying to create absolute returns for you in good, bad, or ugly times.

And those are the kind of the glue we prefer to talk about. And we can talk about why, but global factors. So asset allocation factors rather than security selection factors are likely to be more sustainable. and then you can get more and more down the line depending on how sophisticated you want to get and how more uncomfortable you want to get.

You want to get to like, you know, day trading type of strategies that have complete different term profiles and so on. There's a whole spectrum of improvements you can make. The more uncomfortable you're winning it. But, it is time to move away from your traditional city. You've got a Mulligan. I, it's comfortable to not have to change anything.

But you will have to tell your clients, assuming valuations today, that you're going to have to save more. There's going to be more volatility, and we're going to provide you less return. If you don't want to have that discussion, you need to go out in the spectrum, take some more a level of discomfort and try to provide some added returns to, to the portfolio.

That's what people need to do now,

Pierre Daillie: [00:59:37] Okay, so what do you say to the investor who panicked and got out and doesn't have the mulligan?

Rodrigo Gordillo: [00:59:44] Mike has a good saying there. What's the best of, what is it? And when's the best time to

Mike Philbrick: [00:59:49] When's the best time to plant an Oak tree a hundred years ago? When's the next best time right now? Again, the person who got it was cash, I think is has got to think about how do I reenter this market in a thoughtful and systematic way?

Pierre Daillie: [01:00:01] Psychologically that's easier said than done

Mike Philbrick: [01:00:04] let me give you, let me give you a hard example. All right. Let me give you, let me give you a hard example because I think it might help to illustrate the point.

So we manage an ETF in a, in the U S and it's based on index and the index, Name is, gosh, it's gonna escape me now.

Rodrigo Gordillo: [01:00:22] new found resolve, robust momentum index,

Mike Philbrick: [01:00:26] so the newfound resolve, robust momentum index,

Rodrigo Gordillo: [01:00:30] robust equity, momentum

Mike Philbrick: [01:00:31] index, robust equity momentum index is an index for which there is an ETF.

And, and so let's say, and I like this comparison cause it, it's strictly an SNP. It's an equity momentum, indicator with USF, U S, equities, European equities and emerging equities and bonds and potentially cash. And the way we measure sort of the momentum or trend in those markets is using, ensembles.

And so you've heard of the 10 month moving average where you get in and out of the 12 month moving average where you're either in or out. So in the 10 month moving average at the end of February, you got out entirely, you sold, and you've been in cash ever since. Now, as we approach the end of may. A very dire seasonal period.

That 10 month moving average is on the precipice of getting back in 100% so that's a big, that's a big bet, right? That that's a big enough. What our system does is it looks at many, many different ways in which you could measure that trend. Many types of ways, many different ways to do that. And so it ebbs and flows a little bit in and out.

Currently it's about 90% exposed to bond. And 10% exposed equities. So I got out at some point in February and March. I don't know whenever that was. And now I'm like, well, I made a mistake. I need to get back in. So rather than trying to time that yourself, use the, the newfound resolve, robust momentum, equity, momentum index, put the money in that it's 90% equities and.

And, and 90% bonds and 10% equities. And then each week as the ensemble goes through and calculates again, whether the trend is stronger, has been sustained for a long period enough and time to allocate more assets towards equity, it will allocate them for you on your behalf. Very simple model. This is kind of a one market example, right?

Rodrigo Gordillo: [01:02:28] So you have the difference between a light switch approach. Binary on off, which is what a lot of people want to think is the right way to do it, versus a dimmer switch approach, which is, okay, I'm going to slowly ease in and out of these things, but it's not just randomly, I'm not talking about, okay, I'm going to schedule it on a calendar basis every week.

I'm going to add this much. It's a little smarter than that where you're looking at this hurting behavior phenomenon that we call trend and then understanding that the trend is not just the 200 day moving average. It could be the 150 day, 300 day, the 10 day, the 10 month moving average crossing over the two month, two months across and over at the 10 month at three months crossing over the 12th all of these work over long periods of time independently.

Each one of them is a binary switch, but when you add their votes every time, every week, when you tally up their votes out together, you get a few of them in the short term saying, Hey, you should be back in midterm saying, not yet longterm saying, not yet. And your, and, and all of these are intelligently giving their votes and their opinions as virtual momentum managers or trend managers saying, Hey, I think we should get back in or not.

And they intelligently in and out. Right. So you don't have to have the heart aching decision of having to make a binary all in money. You don't even have to think about putting together strategies like this. You can just kind of follow the index and we'll, we'll, we'll provide a link to it.
So you guys, cause the index landing page has a ton of this thought process in there. There's a presentation, there's a, there's you forget about the index. Just this applies to everything that you do. This ensembles approach this again, we talk about it attacking the investment, everything you do in investments from a place of humility.

This is it. This is what we're trying to, to explain in this landing page. And, and it will help you with anything that you do in life. Anything that you do in investing. And if you CA, if you like the equity markets and just want to play in that space, then this is a solid way. They'll allow you to ease back in when, when it's appropriate.

And you just need to like, you know, follow the index or, or look at the ETF to say, okay, here you go. I know I'm not a hundred percent going in right now. You guys are gonna manage it for me, or the index is going to tell me when to do it. We publish the weights once a week, and and it'll help everybody out that way.

Mike Philbrick: [01:04:47] But you see, you see how that helps that individual they got out. Now they don't know what to do. So now we have to, we have to figure out a systematic, thoughtful way for them to reenter. And so that's just one example of a bunch of algorithms that will do it for you, better. And if you look at those algorithms over time and look at them over 20 years, you find that a tremendous amount of excess return and reduce risk.

So. You're in this particular predicament to the troubling spot, but now you don't have to make that all in or not choice. You could do something as simple as, well, I'm going to, I'm going to wait one 10th a month for the next 10 months to, I mean, you could do that. The challenge is what if the direction continues down and you were right to get out.

The nice thing about finding a, an underlying system. Or, or a methodology that's congruent with how you think will help you stick with it. And, you know, from our broader systems where we incorporate many, many, many more asset classes, and their integration with one another, I think those are very optimal as well.

Because what happens in those places is you get, you get a shock, you get a change in new leadership and new trends. Those leaderships usually emerge out of the shocked time and they are new. And we're seeing that we're seeing, you know, gold leadership. That's. A little bit, you know, different, it hasn't always been a leader here for the last 10 years, but it's starting to show that.

So that's, that's something new that should be incorporated in your portfolio. Are you going to be surveying the landscape to understand that all the time? Are you going to have a thoughtful way to put that in your portfolio all the time considering its correlation to the other asset classes? And so those are things to think about.

Every investor is going to have their. Own choice there, but I think it's, it's, the person should think about a structured, systematic, thoughtful way to reintroduce that capital to markets

Rodrigo Gordillo: [01:06:29] and get back to, self-educating self-actualizing individuals that want to understand upfront what they're, what the plan is.

And then. Have a system, do it for them afterwards where they don't have to get a melt. And that's why we became systematic investors because we were terrible.

Pierre Daillie: [01:06:48] that's the thing with markets. So with investing with this business, the more time you spend in it, the more you realize. How much more there is to learn. The decision making landscape has really changed. It's changing right now and we're near the end are coming to the end of a 40 year cycle of interest rates dropping.

That doesn't make the equity market decision more complicated, assuming you're optimistic about the longterm, but all the other asset categories could either be winners or losers depending on how things go. The most complicated silo is the fixed income silo the interest rates silo.

If you go on assuming that it's a core component of a portfolio. Where do you go where do you you know where do you position your income producing assets or fixed income assets for the long run given where yields are today on sovereign bonds or government paper where do you go for that?

Yields are, you know, under 1%, can you really, from an income standpoint, can you really count on those assets to be there? For you in terms of, of producing an income and the answer, I think in most people's minds is no. Not in the traditional sense, you know, maybe in the, uh, risk management sense. Yes. But it's confusing. It's very difficult. And I think going back to your ETF that you talked about as an example of systematic solution. I think there really is a bright future for those kinds of assets or those kinds of products

Rodrigo Gordillo: [01:08:15] And the sad thing is, there, there, there should be a bright future and it's open. The problem is that, passive investing has won against so far, right? Everybody's, every active investor has been waiting for a decade for this to happen. So that, so you can see active, you need it active. And here we are again with this Mulligan and nobody's learned their lesson, right?
So you really have to find those true, thoughtful investors that have seen this, not as, as proof of passive, but rather as a, a second chance to do it a little bit more.

Pierre Daillie: [01:08:56] I think we can at least agree that it's okay. You know, in one way or another, whether you're active or passive . It's easy to make the equity decision, you know, I mean, even that's not easy, but it's easier to make the equity investment decision. basically as it always has been, we never know when markets, you know, when markets equity markets going to go down, but in the long run they go up right.
There's lots of arguments in favor of equity markets, continuing to increase in value. And the certainly there certainly is one being made right now, but when it comes to all the other asset groups, such as a gold fixed income alternatives. You know, those always seem to be more, more of a toss up and going forward. There's a perception that bonds sovereign bonds will be a toss up in the not so distant future. So.

Rodrigo Gordillo: [01:09:41] but, but see, this is where, again, we get to these beliefs, right? That, that for example, when Oh eight happened, and we got down to 2% yield everybody. Everybody was convinced that there was going to be hyperinflation. It was, it was known. It was hyperinflation with the thing. Why would you want to own bonds? Right? And yet, in any given year, sovereign bonds provided a ton of value and a ton of protection. And it turns out that a us treasury is ends up being the second best performing asset class on the planet for that period.
So. This, this is where we got to move away from. This is where I talk about hubris, right? Okay. So we have low yields and fixed income. I agree that it's a toss up in a lot of people's minds, but, that's, we don't even have to make anything up. Like, German Bunds went to negative territory over the last 10 years.

Right. Have you seen the returns? Their total returns. What happens when you go down? They continue to provide positive returns for investors. Right? And so we got to, at some point, you, you people think about the yield in an asset class rather than the total return of the asset class. Okay? That's number one.

And so what if. The treasuries because what if we go to negative 2% rates across the board, right? And we have what happens to your, your thesis that bonds are terrible. Well, maybe eventually there will have to catch up eventually. There will be a reckoning, but we don't live you, me, advisors, investors don't live a lot of times in a five year period.

We live in a one to three year period where we as those retirees, I need to take money out. They need to be able to have something in their portfolio that makes them money. So what happens if we go through a period of deflation where a negative 2% yield is better than the negative 3% CPI? Right. You're having a real positive yield there, right?

By owning bonds and equities will have lost money and gold will have lost money, and the only thing there for you is going to be fixed income. But you decided to throw it out the window because your thesis was that low yield equals bad return. Right? And it's just, it's, it's really, it can really bend your mind once you go to those levels there was a period from 1940 to 1981, sorry, 19 yeah, 1940. It was a 40 year period. 1940 to 1980s where the 10 year treasury lost money for that whole period. It had a drawdown, a 68% in real terms. Right. And so who in their right mind. Would own a risk parity in that approach. Right? Why? How could you?

Well, it turns out that when you add that that bond portfolio for those 40 years that lost money to gold and two equities. The, the equities, commodities and the equities more than offset the losses for the fixed income. And the fact that they were not lowly correlated to each other meant that the risk parity portfolio was a lot smoother than just owning equities, just owning commodities and just owning bonds.
And if you were okay with the volatility of equities, all you needed to do was leave with the risk parity portfolio to equity like volatility, and you would have outperformed equities, right? So once again, this concept that risk parity would have blown up or will blow up if, if bonds do poorly is also not true, right?

It's the, you got to think about the ensemble. You got to think about the risk adjustment. You gotta think about the reduction of your tail risk and. And if you can use leverage to, in order to achieve the risk profile you want, you're still better off being diversified than not being diversified. And we do have to break out of these easy mental models of, well, yields are low and therefore everything's low.
if it comes to you easily, it's probably wrong. You got to think two, three levels deeper, like...

Mike Philbrick: [01:13:28] Stocks garner their earnings from GDP growth. Interest rates are a function of the demand for money in order to deploy projects that would provide positive or creative growth for GDP. If they can't, then they're not done.

When you have very low or negative rates that says more, that has more negative implications for equities than it does for bonds. Right. So, so if you have negative rates, that means the demand for money is nonexistent. That there, there is no project that can be done to create any kind of future demand or growth in GDP.

That's what it's saying, deflationary. And it would be unusual to expect, Equity markets to have some sort of massive, growth in earnings. so it's a, it would be a strange thing. It could be that massively capitalized stocks are the only thing that can predatorily make money and cannibalize all other small businesses that has some feedback loops on growth that are, that don't quite make sense as possible.

I mean, I can dement the world enough where I could probably come up with it. The equity markets. But because their, their growth and earnings just becomes bigger and bigger part of GDP and so they grow, but the global economy doesn't, that's a bit of a weird scenario, but low rates and negative rates or the demand for money for future projects when they're that low, that's not, that's not a great sign for equities.

Pierre Daillie: [01:14:53] No, it's not. I mean, it's a demand. It shows that there's a demand , a willingness. To pay for safety. And so, yeah, in terms of the return of capital that you're willing to accept, uh, you're willing to accept that you're getting 98 or 99 cents back on your dollar. ,
The Fed's plan and the government's plan is to drive us into risky assets, uh, by giving us basically what amounts to an ultimatum, uh, or investors contemplating. Investing in sovereign paper with negative rates. You would only do that if you were willing to pay for the safety net of a government guarantee.

What they're doing is they're they're plan is to swap out a old bonds, uh, for new bonds and the old bonds have typically a higher coupon rate and they're buying them, they're burying them in the backyard and then they're issuing. Replacement paper at the lower rates. And that's really what their purchase program is all about. It's about swapping higher interest rates swapping out paper that pays higher interest rates in return for paper with lower interest rates.

And that too in itself is the reason why. Uh, all of this quantitative easing that we've had for the last, uh, 12 years. Hasn't been hyperinflationary.

For investors though, in the paper. Yeah. You would continue to benefit from falling rates even into the negative territory. So that's why, a lot of professional fixed income people are basically suggesting you know don't get out of your government's just yet.

For exactly that reason, which is that just that, you know, the ride's not actually over at zero, it does continue on below, but that's not the problem you're actually facing. But that's where that's really where the decision making landscape is becoming more and more complicated, more confusing. Overall i mean because you're not just going to own a hundred percent equities in your portfolio
And that's why. That's why this discussion is really valuable. I think investors, are wondering, where do we go from here? And I think, I think you guys are on the right track .

Mike Philbrick: [01:16:59] That sounds like you're wrapping this up.

Pierre Daillie: [01:17:01] Before we go, you know, we've been locked up for a couple months now. What have you guys been doing with your time i mean you know we've had a lot of time at home have you guys got any recommendations for anything you've been streaming on netflix

Rodrigo Gordillo: [01:17:18] i, you know, I haven't been able to see a minute Netflix. I fall asleep about five minutes into everything. I know. Everybody's like, Oh, have you been watching? It's like, where do you guys find the time? I used to have a commute where I used to be able to listen to podcasts. Now that's gone, right? So I wake up, I start making breakfast.

The kids get up, fix them all up. My wife helps me out. Then I go straight to work. Right. Cause there's no commute. I just might as well start work. Then do all the work. At five o'clock, I started, you know, helping with dinner and mingling with the kids. Then it's bedtime. Then by the time I get the opportunity to even think about Netflix, I'm, I'm asleep.

I don't even know where does everybody else by that time.

Pierre Daillie: [01:17:59] That's when you pass out. Have you watched The Last Dance?

Rodrigo Gordillo: [01:18:09]No. Everybody's telling me. I've watched Save The Last Dance. Anyway, you guys, everybody should look up Save The Last Dance here. It's much better than, than The Last Dance.

Mike Philbrick: [01:18:16] I was very happy to have saved Ozark for, for the pandemic. So we got, we got through Ozark and, and The Last Dance and I found some actually really interesting, very positive net effects that have come out of this in that, Something like online poker. So I like to play poker. It's something I enjoy. but I don't really trust the online game as much, cause you know, you don't know who's there. You don't know if they're collaborating. And it's kind of one of those things where, you know, I'm, I'm all up for that, but I actually enjoy the conversation of other people.

That I know, and we're all, you know, we're all trying to shark each other's money. it's all small, very small stakes, obviously. but it's the conversation that happens around, you know, it's something to do with your hands and to gather and chat. And so, you know, I'm playing a little bit of online poker through the home games.

Like a lot of the a lot of these apps have a home game where you can play a 1 cent, 2 cent, whatever, whatever your stakes are, and however you want to sort that out. but is allowed for like this, this rich, Almost noninvasive because we will set a time and even we play a little bit with our colleagues and, and we'll set a time.

So seven o'clock on Saturday night, we're gonna whoever can join, we'll join a game and we talk about everything from the books that we should be reading. You know, the three body problem to, you know, Hyperion, all kinds of different weird stuff. You might read what the various, COVID conclusions are, where the, where the, where the science is, Bubkis you know, BS and where the science is more rigorous and we have these great conversations. And then, you know, to show up. At 7:00 PM means that you have to like get off the couch. You're like, Oh, wait a second. It's six 55. You don't have to commute to somebody's house. You can have a few drinks. You don't have to worry about the commute home, because the commute zone, you turn on the zoom and you, and you just get this really rich conversation, which you don't, you don't do otherwise. so I

Rodrigo Gordillo: [01:20:11] Mike puts on the music in the background. It's fantastic. Yeah, I agree. I think the, So I have two games go on, one with the Resolve crew and people that we know in the industry. And then another one is my friends from college where we could not for the life, get, get a game together once a quarter.

Now we have it when we're doing it every two weeks. And it's the same idea like, and, and what we have now is everybody joins. Somehow. It turns out that we could have the guy from my Yorker join with a guy from Singapore with a guy from Peru and the guy from Vancouver. All. Everybody just kind of plays around with the time zone a little bit.

And you, you have this amazing catch-up and we, we've realized that there's, that this is likely to continue after everything goes back to normal. So definitely zoom has been key, but gathering around a game is been instrumental

Mike Philbrick: [01:21:02] And you and your brothers, right? Your brothers from,

Rodrigo Gordillo: [01:21:04] Yeah, we played, we found a Peruvian Cachito, which is a, it's, yeah, it's a Peruvian, it's called Liar's dice.
They have an app for that. It's similar to liars poker. The game that you play with, with your dollar bills, the U S dollar bills, and yeah. I can't. Talk to my brothers and argue for four hours, but I can play a game and argue with them for four hours. And that's been kind of nice. So definitely find your crew if you're not doing it already.

Get on a zoom, find your crew, find a game, that you're all willing to play, set a time and do it over and over and go. I got to say, if I don't have that on a weekly basis, I do feel like I'd be going a little insane. And I think it's because of that comradery, in that discussion that that kind of free time.

Well, I've been able to stay sane and it's, I'm one of the lucky ones in this world that has not really been affected emotionally or, or in, in terms of the business in any meaningful way. So very, very lucky that we have internet and B outcomes right now.

Mike Philbrick: [01:22:04] I got it. I got it. My last recommendation is kind of make me sound like a super nerd, but I'm back to playing Dungeons and dragons.

Pierre Daillie: [01:22:13] That's terrific.

Mike Philbrick: [01:22:15] I have a group of super nerdy buddies that, that you'd all know and love and it's surprising who they are and, you know, it's, it's a very, it's probabilistic game. The end is a very interesting way to tell a story. And, the, the five, eight edition, it's surprising the popularity surgeons it is experiencing now.

That might be just me cause it's going to feed me whatever digital media that I'm into. So all I can say is like, Holy mackerel, everybody's doing this, which I'm sure is probably not the case with stranger things. Yeah. Well, you know what? You're absolutely right. You're, you're, you nailed it. I forgot about that.

The stranger thing, I remember when I'm watching that and I'm like, Oh, I used to play Dungeons and dragons and my kids are looking at me like. Why? Why are you still here? Okay.

Rodrigo Gordillo: [01:23:01] But the wonderful thing about that, those discussions we've been having were so awesome that somebody wants to mention, you guys should have that live. so that, that drove we, we did our first live event on Friday called the, the Resolve Riffs podcast. So we have a podcast already. and if you look at Resolve, it's a Gestalt University. But now we're going to do on a weekly three o'clock live, invite everybody to pipe in and ask questions. And, the first one that we did on tail protection was a huge success.
We had a lot of fun with it. It doesn't feel like a job and it came out of these, these discussions. Right. So, yeah.

Pierre Daillie: [01:23:36] Good stuff do you do you find that you guys that you guys have been less busy or busier?

Rodrigo Gordillo: [01:23:42] and busier, you do more work. You do more with whoever thought, whoever said that, having a remote workforce is going to reduce efficiency was clearly wrong. It's just you. You just work more and more. My steps. I got my aura ring here.
I've been cut by 80% I simply do not move from this space. That.

Mike Philbrick: [01:24:05] I think that's the thing that you need to do that I've needed to do is sort of schedule walks, schedule outdoor time, really be focused or diligent about making sure you get your exercise in, because you usually would have the walk to the, you know, whether if you're commuting, you walk to your car and then you park, or you get to the, you know, downtown, they're going to walk to your office.

You probably get in a couple of kilometers. Just in your commute, and then, you know, walk down and get lunch here. It's like, well, it's a seven step walk to the lunch cafeteria. It's seven walk to the bathroom. You, you do have to make sure you prioritize. You're interspersing that, that activity into your day.

Pierre Daillie: [01:24:44] Yeah, I've been, I've been listening to a lot more podcasts in during that time, but I find that I've been going, I've been scheduling the walks after I found, after a couple of weeks, I was sitting on my ass for, you know, 10 hours a day in front of the computer. you know, not really doing anything to get my blood flowing. that's that's when i get my podcast listening time in.
But. Love it guys. It's been really great. It's been great to get back together with you again and catch up. And it's been a really great conversation today. I think everyone's gonna love tuning in. Uh, thank you. Awesome

Mike Philbrick: [01:25:20] you as well.

Rodrigo Gordillo: [01:25:21] Pierre always a pleasure.