INSIGHTS

 

If 2021 was the year of ‘peak stupid’ in markets, is 2022 the year when everything breaks? Robin Wigglesworth, Alphaville editor at the Financial Times and author of Trillions, joins Peter van Dooijeweert to discuss the disruption in the UK government bond market, the passive investing revolution and the future of trend-following.

Recording date: October 2022

Episode Transcript

Note: This transcription was generated using a combination of speech recognition software and human transcribers and may contain errors. As a part of this process, this transcript has also been edited for clarity.

Peter van Dooijeweert:

Thank you for joining us today. I am delighted to be joined by Robin Wigglesworth, global financial correspondent for the FT, and now, actually, Alphaville editor at the Financial Times. He’s also author of the best seller, Trillions. Robin, thanks for joining us on the podcast today.

Robin Wigglesworth:

Well, thanks for having me on, Peter. It’s a real privilege.

Peter van Dooijeweert:

We’re going to cover a lot of different things today, but I want to start here. Last year in markets, at least for me, I think is where we reached what I would call peak stupid. We had Archegos at peak leverage, we had meme traders versus hedge funds, QE, fiscal stimulus throwing fuel on the fire. One of the last times we talked, I think you even mentioned, or I said it was a Candy Crush type market, i.e. Robinhood had become more of a video game. Maybe this year, we’ve gotten to the other extreme. We’ve got the inverse Jim Cramer ETF. We’ve got the opposite of ARC ETF, so have we gone from peak stupid to something else? Are we breaking things with Central Bank interventions?

Robin Wigglesworth:

Yeah, well if we were a little bit drunk on all that Central Bank liquidity last year in fiscal stimulus, I think this is the nasty comedown. It has been pretty remarkable how quickly things have shifted and I think a lot of people going into ’21 thought that was when we were going to pay the piper, as it were for the measures that we did in 2020, that inflation was going to go amuck in 2021, the markets were going to crash in ’21, and actually, this was a little bit delayed and lo and behold, this year has been pretty much a nightmare for everything. If we had everything rally, we have everything crash in 2022.

Peter van Dooijeweert:

Yeah, I guess maybe this year’s forays into some of the silliness from last year haven’t been particularly well rewarded, if I were to sum it up.

Robin Wigglesworth:

No, I think it’s always tempting to see stupidity get punished, as it were, or dumb stuff or dangerous stuff get punished and markets, they don’t always work that well, right? I mean, people do the right thing and lose money. People do the wrong thing and make money, but it’s pretty clear that anything that went up the most in the previous two years has generally been pummeled the most in 2022, whether it’s crypto, some thematic ETFs, mean stocks, the whole works, but there’s still a lot of stupidity out there. Sadly, it’s not something that is a resource that we run out of in humankind.

Peter van Dooijeweert:

Yeah, I think exactly, that’s right. I’m going to borrow a quote that you quoted, which is, there’s nothing so dangerous as a supposedly safe strategy as we transition. We try on podcasts to be somewhat timeless, but I think what’s happening in the UK and Gilts is something maybe one of the defining stories of the post Covid era. Hopefully, it is one of them and it’s not some footnote to something even worse. I guess, give us your take on everything LDI and budgets and Gilts.

Robin Wigglesworth:

No, it’s been absolutely fascinating for a financial journalist like me. It’s interesting, of course, there’s lots to write about, but I do think, like you say, that this is really about the past decade coming home to roost, as it were. On one hand, LDI is an incredibly boring subject. I know people in fixed income that haven’t really followed liability driven investing, the actuarial mathematics behind it. It’s a way to de-risk a pension plan, but as we see sometimes, quite often the safest strategies, what you thought was perfectly safe has a really nasty tendency to be revealed to be quite high octane when the mood music shifts, as it has this year. We’ve saw in the LDI the explosion of defined benefit plans, switching more and more to an LDI strategy to plug and de-risk the pension schemes.

They’ve done so by using interest rate swaps. I’ve been covering LDI. I knew about this. It was a big driver, especially on the long end of the UK market where it’s a huge driver. I have to admit, I did not appreciate sufficiently how much they were basically getting synthetic long exposure and just how violent things could get when we had massively out of bound selloff in the Gilt market triggered by the fiscal event of a couple of weeks ago and then how that rippled into just mass margin calls across the pension fund space. It’s been fascinating to see.

Peter van Dooijeweert:

I guess maybe not everyone listening is going to understand the story. I mean, oh, you’ve described as they hedge their liabilities, so why does that hurt? It shouldn’t cause any trouble if I’m just reducing risk, no?

Robin Wigglesworth:

No, that’s true. I mean, it boils down to the fact that defined benefit schemes discount their future liabilities, the cost of the value of the future liabilities with long term yields, so as long term yields have formed, it becomes harder for pension funds to make a safe, solid return that they can promise their policy holders or their members, so they bought long Gilts and duration, in general because basically, when yields go up, essentially that’s good for them. Their funding ratio improves, and when they go down, well they’ve bought a lot of durations, so they make it back on the assets. They’re matching in theory, their assets and liabilities, but in practice, these things quite often fall apart. There are many examples of that where something that is in theory and in practice should be completely fine and in fact, a conservative solid way of doing things. The details really when they interact with markets and practice, weird stuff can happen. I think we’ve seen that in the last couple of weeks.

Peter van Dooijeweert:

Yeah and I guess part of the story isn’t just that they’ve matched off their liabilities, because that in and of itself would be fine, but as the Gilt market moves, there’s a margin call, so there’s cash that needs to be generated. On the right side, you have this hypothetical liability that gets hypothetically marked without a cash flow and on the other side of the balance sheet, you own a bunch of assets on leverage, potentially, that do move around and you have to post margin. I guess that gets to my second part. They own a lot of other things, right? It’s not just Gilts that are part of the story here.

Robin Wigglesworth:

Yes, like you say, it’s basically a mismatch between the theoretical long end liabilities and the very real margin call you’re getting from your counterparties today because essentially, you were long interest rate swaps and other things. Yeah, I mean in that case, you have to meet that margin call. It’s a liquidity problem, not a solvency problem. I do see sometimes, also, in the financial press because it’s sometimes tempting or through ignorance that you scare people into thinking your pension plan is going bust or this is the liquidity issue, primarily, but they didn’t have enough liquidity to meet these margin calls, so they had to sell everything that wasn’t bolted down.

They ended up selling Gilts, long Gilts. They sold linkers, they sold corporate bonds. They sold anything they could sell to meet these margin calls. Of course, that snowballs things, sends yields even higher and triggers the new round of margin calls. That’s what the Bank of England, in the end, felt it had to step in and arrest that feedback loop.

Peter van Dooijeweert:

Yeah, I think they increased allocations to private assets. Where does that fit into the story?

Robin Wigglesworth:

Yeah, I think this is one of the most fascinating trends over the past decade that we’ve seen this massive migration of capital, especially in the institutional space where the pension plans, insurers, endowments, sovereign wealth funds into private capital, essentially, private equity, venture capital, infrastructure, real estate, direct lending funds and so on. I think it’s because fundamentally, they could see sometimes return challenges in the public markets. As markets rallied higher and higher and yields fell low and lower, you just couldn’t kid yourself in thinking you were going to make your return hurdle in the public markets. In the private markets, you could at least, I mean sometimes kid yourself. I think in reality, I don’t think private market returns can be divorced from public market returns forever, but at least you could plausibly look yourself in the mirror and say, “Yes, I can totally make 15% consistently no matter how much money mean my peers allocate the private equity”. Those returns will always stay around 15 to 20%.

Also, cynically, but I am a journalist, so I’m pretty cynical, I think the artificial smoothness in private capital is incredibly tempting when you’re in a big institutional investor. You don’t really want to see your portfolio move around with every stock market puke or bond tantrum. The fact that private markets, there’s a little bit more flexibility on how you mark stuff and when you mark it, I think is very, very enticing. Of course, the problem is that yes, if you are, let’s say a pension plan that had before 10% of your money locked up in illiquid stuff, you still had a 90% liquid-ish portfolio that you could sell to meet margin calls, to meet pension liabilities and so on.

If you’ve been jacking up the private side, you maybe have 30, 40% of your assets locked up for years to come, it puts a lot of pressure on that remaining liquid bucket. I think we’ve definitely seen some of that in the UK now, but it is what I worry could end up being a bigger, broader problem in many other parts of the world in the coming year or two.

Peter van Dooijeweert:

In a way, I think it’s something that Cam Harvey alludes to, our tendency to use a back test to evaluate how well something’s going to work and the back test of boring LDI plus stable private credit and private equity creates a wonderful outcome.

Robin Wigglesworth:

Yeah, no I’ve also heard it called a peso problem in that this was, I think when Mexico, you link basically pegets, its peso to the dollar and then if you look at the back test, it looked like, obviously, it was free money to borrow money in the US and put in Mexico until ’94 when suddenly something that was not in that back test suddenly bit you in the ass. I think the world is just filled with peso problems, but it’s stuff that doesn’t appear in the rear view mirror, stuff that is almost inconceivable to us and markets have a nasty, but at least for me as a financial journalist, hilarious tendency to throw these curve balls at us all the time, which is why, yes, everybody loves a good back test, but I think the wise people know not to rely on them too much.

Peter van Dooijeweert:

Which I guess makes me think a little bit about Sterling and urdu on the other day making some comments about the financial stability of the UK. I mean, ignore his comments, but I guess it’s been a strong dollar year. We see it across our systematic strategies, so a trend is in following the dollar strength all year. Is the Sterling story the dollar story, is it something broader? What’s your take on it and what are you hearing from people?

Robin Wigglesworth:

No, I think it’s both. It’s very rarely just one thing in markets. Starting with the UK side, I mean clearly the UK has massive economic and financial challenges. This is a country that has been running a pretty outrageous current account deficit for what, 10, 20 years now and a huge budget deficit. The UK is a very advanced developed economy and I think it can do so for a long time. The GDP is far low than it was during World War II and back in the day, but the UK has huge challenges and I think people have been worried about that for a long time. The fiscal event, as the UK government put it, landed at a very inopportune time and just was the snowball that got that avalanche running, essentially. I think this is both current events, historical backdrop and UK issues that drove Sterling to a large extent.

Like you say, I mean it’s not just Sterling that’s been weak this year. The euro has been weak, the yen has been even weaker. I do think the broad macro backdrop is a strong dollar regime that we have seen in the past, but I do think this is somewhat different and even more unique. I actually think the world is probably even more dollarized or dollar based than ever before. I do worry that, essentially, what we are seeing is the Federal Reserve hiking until things break and things are going to break abroad far before we see stuff break in the US. That is, I think the thing for me, as an observer, at least, I worry the most about right now.

Peter van Dooijeweert:

Yeah, I think that’s exactly right because US data still looks okay, but certainly the Gilt market doesn’t look okay, regardless of what the interventions are. We have clients and people saying, “Wow, look at the yield change today. They’re up 30 basis points” but looking at the price impact of some of the things in the LDI, funds down 25% yesterday, that’s not 25 basis points, that’s 25%. I think going to your point on the Fed, so not to flatter you, I follow you on Twitter and, of course, in Alphaville and one of the things that you posted that is around this idea of Fed breaking things and you mentioned Fed Governor Waller comparing the bond market to pumpkins.

Robin Wigglesworth:

Yes.

Peter van Dooijeweert:

And Halloween. I mean find that’s extraordinary that anyone could think of something so trivial when it has such impact.

Robin Wigglesworth:

No, I mean as a journalist, I attend towards being on the surreal side. We’re always worried about the next thing. I think a lot of us are in the market participants and journalists scarred by ’08, so we’re always looking for the next big disaster to happen. I think bonds selling off is entirely natural. It’s entirely natural, given the macro backdrop. I think the concern is always when it becomes disorderly, chaotic, causing feedback loops or real serious systemic damage. For example, the UK pension space, and I do think policy makers are very aware of these things. I was struck by Chris Waller’s comments and in his defense, I like it when Fed officials or anybody expresses themselves in colorful metaphors. I have to admit, I was shocked that he would compare liquidity in the US treasury market, which has atrophied quite dramatically and I’m genuinely worried about the fragility of that market to the market for pumpkins around Halloween.

I like the flippant that side of it, but if it betrays, and I think it does, a cavalier attitude to the health of the US government bond market, that makes me very worried. The UK Gilt market could break and that’s a global event, but it’s not a global capitalism. The US treasury market, and we saw this in March, 2020, I think came perilously close to a very serious problem and that’s a global financial crisis on top of everything else.

Peter van Dooijeweert:

I think that’s the interesting thing about March, 2020, the bond market was going the opposite direction of what the Fed intended, whereas now, the bond market is going in the direction the Fed intends, so if they’re going to be cavalier about the direction, then the magnitude is going to become incredibly problematic, I think.

Robin Wigglesworth:

Yeah, and there’s a tendency among market participants, as they call themselves too, they always blame the Fed or central banks in general for whatever they do, so when yields are falling and interest rates falling, oh they’re wrong, it’s too easy, policy’s too easy. As soon as they switch, oh it’s too tough, they’re breaking the world, it’s all going to hell. I broadly think central banks have not been infallible by far, but they’ve done a pretty okay job. I agree, frankly, with what they did in 2020. I think the fact that we didn’t have a global financial crisis on top of everything else going on is largely thanks to them being super aggressive and now, we pay the price in the form of higher inflation. For me, that seems to be a decent trade off that we didn’t have a global financial capitalism in March, 2020 and now, the cost is higher inflation and interest rates are going to go higher and bond the yields are going to sell off and people are going to lose money. Frankly, in most markets, you’re still looking at pretty healthy profits over the decade.

Peter van Dooijeweert:

Pretty healthy profits and I was chastised by Luke, our CEO, for making the comment that equity vol just hasn’t picked up and hasn’t been a crazy year in equity volatility. He looked at me, he’s like, “Mate, the Gilts market”, but in fairness, equity vol hasn’t been there, right? It’s not the typical shock. We’re 10 months into a 20% decline. Are you hearing much about why that’s the case?

Robin Wigglesworth:

No, it has been fascinating that diversion between rates and equity vol both implied and realized. I, actually, think that shows that this is so far, with some notable exceptions like the Gilt market has been in oddly adjustment. That markets are down is not a systemic issue. Markets go up and markets go down, people forgot that, but that happens and it’s fine, it’s healthy. I think so far actually, if you told me before the year that the Fed would be jacking up rates by 75 basis points in multiple meetings in a row, I would’ve predicted carnage by now.

Actually so far, maybe the financial system is just a little bit more resilient with maybe the UK as an exception, than we gave it credit. I think that’s why the equity market is pricing in the fact that the risky rate is going higher. That flows through to many areas. That will cause, probably a recession, but we don’t know how deep it is. If it ends up being a deep recession, then equity marks will sell off more and equity will go higher. If it ends up being a softish landing or a soft recession, then that’s fine. Maybe it’ll be like 2000’s after the.com bubble where the market’s puked, but the economic impact wasn’t really that terrible. That’s what I’m crossing my fingers for, at least.

Peter van Dooijeweert:

Yeah, I guess it’s the least interesting story is market properly adjusts to rates, so for time and everything is fine. It doesn’t make for a very good reading. I’m going to jump around because I actually want to talk about your book a little. It’s been out, so this isn’t meant to be promotional, it’s been out for a while, but it’s such a great read and there’s some good anecdotes. Actually, I’m going to attempt to tie this back to quantitative strategies in the end because after all, we’re here to talk about quantitative strategies. I’d like to start off just the genesis of the book in terms of Trillions is about the creation of passive investing, basically, if I’m going to sum it up in one line, maybe not perfectly. I like the AT&T story for example, and Wells Fargo and Samsonite. Can you just talk about those, just share the story again?

Robin Wigglesworth:

No, I mean the index funds, it is the original quant strategy. It was the first strategy that was really enabled by the computer error on Wall Street and using computers, the massive hogging mainframes at the time to crunch actual data to find out what was a good investment strategy. They were the OG quants and yeah, so Wells Fargo is where it got to the promised land first. They were led by one of the firsts of engineers, mechanical engineers end up on Wall Street and you actually learned to program and IBM 301, I think it was back in the day and you worked at Wells Fargo. They didn’t have any buy-in for this index fund. I mean they didn’t even call it an index fund. I think it was the market portfolio inspired by Bill Sharp’s work, but it was AT&T and Samsonite that were the first backers of this.

Samsonite got there first, most because the son of the founder had studied at Chicago. He’d studied in Chicago in the 60s under people like Gene Farmer and others like that, so obviously, he believed in market efficiency. When he started working at the family firm, he looked at the pension plan of Samsonite and saw just a bunch of useless active fund managers that were doing a bad job and charging a lot of money for that. He called his teachers and Bill Sharp as well, who he knew a little bit and said like, “Does anybody manage money in the theoretically sound way?” They all directed them to Wells Fargo and Mac Mcquown, was called and together, they set up the first, not index fund, but indexed strategy in 1971. It was just basically separately managed account on behalf of Samsonite’s pension plan that tracked the Nizi and it was also dollar weighted, so it wasn’t market cap weighted.

It was, frankly, a bit of a mess to do, so they hadn’t really followed through on the execution side. Any strategy can look good on the back test, but sometimes when it hits the road, you realize the wheels don’t work or the execution, it lets you down. I know you guys spend a lot of time working on execution costs. They hadn’t really done that side of it and this is the pre-electronic trading era. That was the first one, but I think the prime mover behind indexing really taking off in the 70s was AT&T’s pension system. They were called Baby Bells. They were all splinted into different parts, but they all talked to each other and they basically were the biggest institutional investor in the US equity market.

They basically invested in hundreds of active equity fund managers and occasionally, they get together and look at it and well actually we are kind of getting the market return minus all these trading costs and trading costs were huge at the time and also, the cost of compensating the portfolio managers. That’s why there were several of the Baby Bells, especially Illinois Baby Bell, I think was the biggest prime mover, started writing very, very big checks at the time to the first three index funds, which was Wells Fargo, American National Bank of Chicago and Batterymarch in Boston. That was the genesis for the passive revolution to come.

Peter van Dooijeweert:

I think they get attacked from both sides. You say that often, which seems unfair.

Robin Wigglesworth:

Well, everybody gets attacked once they’re big. No, I mean there’s so many attack points against the passive boom, some of which I think are hog washed. The idea that passive has made the markets more prone to boom and bust, more volatile, less volatile, less inefficient. There’s so many things. I mean for all sorts of reasons, I think it’s generally self-serving or flawed. I think that there are issues around the power that accrue to index providers themselves, so the people that create indices, they’ve been called gatekeepers of capital. I don’t think that’s unfair. I think there’s too much innovation, maybe, going on in that space that not all index funds or ETFs are created equal. There’s a world of difference between let’s say, world equity index fund being sold at seven basis points and something that’s like a triple inverse VIX ETF or ETN.

I think the hardest problem, and I think the one that’s going to become the biggest issue, frankly, has become a bigger issue earlier than I thought. When I wrote this book and I was writing VFP, it wasn’t front and center, but it has certainly become so in the last year or two but is the fact that the economics of index funds means that the big will become bigger and already the big three, which are BlackRock, Vanguard and State Street in that order, are huge. They are the single biggest shareholders in almost every single major US company already and quite a lot around the world.

Given where we’re heading, it’s not inconceivable that within the next of 20 years or so, they will control 50% of the shares of every major company in the world. Now, trees don’t grow to the heavens, right? There is, maybe at some point, a finite limit or there’ll be antitrust busting. Where we’re heading, I think, is something that makes me a little bit uneasy and increasing quite a lot of other people as well, it seems.

Peter van Dooijeweert:

What does that do for shareholder votes? Does it make companies beholden to those three or are they lazy in terms of how they vote?

Robin Wigglesworth:

Well, I mean this is why I think this has become a really fascinating subject. If you move beyond the statement of fact that they’re already quite big and will, in all likelihood, become even more dominant in the shareholder registry of companies, what does actually mean? Now, I don’t believe there was ever a golden era of corporate governance. I think that’s complete and utter bullshit. I think it’s something that people come up with. There was a golden era of TV or music. It’s like we always think music from our early teens or late teens was the best and all modern music is terrible. I think corporate governance used to be atrocious and I think it’s generally better now. Are passive investors better or worse at corporate governance? Well, that’s a qualitative judgment. I can see the arguments on both sides that on one hand, and this is an argument that BlackRock and Vanguard make a lot, that they are defacto permanent capital.

If you have a bad quarter, hedge fund ABC might get the hell out of Dodge the next day and they just won’t stick around. If even a call icon rocks up on your registry, he might harass you for a few months, maybe a few years, but fundamentally, he’s not probably going to stick around either. Vanguard is going to be there forever, so you have to listen to them. Do they have enough people to actually exert proper control? People say no, they don’t. They’re lazy. They still devolve too much to Glass Lewis and ISS. I think, frankly, most active managers probably do that as well. That’s the dirty secret. Active managers aren’t much better on that front. Then, obviously, at some point it gets to the point, well are they too controlling?

I think that’s where we’re getting more concerned. Now, the criticism for the past decade, there’s mostly been that index funds are lazy owners, that passive investors, they’re passive owners and they encourage, or at least don’t discourage corporate sloth and waste. Now, I think the worry is that they are becoming overly active because pushed by things like ESG that they are getting involved in stuff they really shouldn’t be getting involved in. Should they be dictating to an oil company that they should no longer be an oil company? I mean they would say they’re not doing that, of course, but that’s the perception. Then sadly, occasionally, perception does become a little bit reality, so this becomes a very noisy subject over the past just 12 months, really.

Peter van Dooijeweert:

Yeah, and I think that’s definitely the case of executives are going to make political statements on some of these topics then you’re naturally going to have some debate on that topic, whether you like it or not.

Robin Wigglesworth:

Exactly. It’s unavoidable.

Peter van Dooijeweert:

I have two distortive effects that I want to talk about. One, I’m going to see if you think it’s a myth and the other one I’ll argue hard with you if you think it’s a myth. The first one is that everyone buys passive, so when they unwind, the market’s going to crash.

Robin Wigglesworth:

I mean it feels a little bit like if you drive a car then if you crash, there’ll be people hurt. Fundamentally, people need to evolve from seeing an index fund as something unique unto itself. It’s just a vehicle, a way of packaging up a strategy. Yes, if everybody pulls out, if we all pull out all our things from stock market tomorrow, whether it’s in active funds or index funds, will the market crash? Well, yes, there’ll be more sellers than buyers and stocks will puke, but it doesn’t change whether it’s an index fund or active fund. Active funds, they will typically carry more cash than an index fund, so they have a bit of a buffer, like an index fund, if you pull money out, broadly speaking, it does have to sell but in practice, what we’ve seen through every big downturn is that money and passive tends to be stickier.

There’s been some suggestions around this. I think it’s because on one hand, I have a low view of the common intelligence. I think we do dumb things in isolation and there’s groups all the time, but broadly speaking, if you give people enough information, they don’t do heinously dumb things and they accept that. If you buy an index fund and you say, “Look, if the market pukes 20%, you’ll be down 20%”. They’re not going to like that, but they’re okay with it. It’s okay. If you’re an active manager that says, “We’ll offer downside protection when the market pukes, we’ll be coasting, we’ll be nimble”.

Actually, lo and behold, on average active, that actually does worse around the big breaks because usually most have, on average, been leaning into risk. Actually, you’re going to hate that. That’s when you pull out the money. If you look at the big fun flows around big breaks like ’08 or March, 2020, money in index funds was actually surprisingly sticky. I think there are micro issues around things like ETFs in illiquid asset classes, although dare we become more positive around that, as well. I think that myth, at least, is not one I’m worried about in that I’m sure at some point, we’ll have another major market break and people will blame index funds because lo and behold, index funds will be close to the scene of the crime because they’re everywhere now, but I don’t think that will fundamentally change the reality that active is the price setter and passive is a price taker.

Peter van Dooijeweert:

Then, I’m going to go the one which I largely agree with what you’re saying. We crashed well before in 1987, 1932. We found lots of ways to go down in asset classes without passive, but the ETF market is one where on the one hand there’s about, I don’t know, 10, 50,000, who knows how many ETFs in the world, so you’re making a discretionary choice there anyway. I’m going to say there’s some part of the passive market isn’t passive, but what really bothers me in the ETF market, and I come from risk mitigation background, are leveraged ETFs and what I would call bastardization of passive and giving retail, not guns, but AK47s to just go shoot around in the markets.

Robin Wigglesworth:

No, I think we are completely on the same page here in that I think active and passive, they’re very useful short hands, but every shorthand and certainly when it comes to some convoluted subjects like finance and markets, they miss a lot. There is no true active in that many active managers aren’t practice to varying degrees, passive index huggers. They always have been through history and they still are to this day. We know where there are various ways to show it. That doesn’t necessarily mean that bad, it’s index oriented or index aware, but they hug an index. They’re not purely truly active and many big active shops use ETFs to express a view. The same way, obviously, passive. Like you say, you are making a choice between buying an S&P 500 index fund, a total stock market fund, a global equity fund, the Russell 2000, the Russell 3000.

There are all sorts of active choices throughout that process that makes it not perfectly passive. Actually, I mean the construction indices is, to a certain extent, in most cases, actually a qualitative approach, not just a quantitative one. I have, actually, always seen passive as, frankly, you talked about early, like cheap quant, but that’s how I see it. I think, actually, it’s a continuum of complexity, but systematic strategies and index funds and ETFs are the dumb, very simple, very cheap systematic strategy, which is buy all the stocks according to the S&P 500. Then on the other hand, you have strategies, like some of the ones that use that are systematic but highly complex, highly sophisticated, and therefore more expensive.

Yes, I think some of the leverage ETFs and that the ETFs, especially have evolved from something that was a way to wrap up a tradable passive product to just becoming a broader, more powerful wrapper in its own right. I, actually, think it is possibly going to support the mutual fund, unless something like a better wrapper comes along. We can see the ETF as a set, not just in passive products, whereas most of the AUM still is, but more and more active strategies are getting packaged up. I think if you put up an active strategy, like ARC in an ETF, I don’t think that strategy is particularly smart, but at least you’re not pretending it’s passive. I do have a problem with the leverage ETFs, the inverse ETFs, because frankly, I think they seem to me, if they quack like a duck, look like a duck, sound like a duck, it’s basically a way of circumventing regulatory controls around what kind of derivatives ordinary investors can and gain exposure to. There are products here that just have no conceivable value to anybody, except the market maker and the product manager behind them.

The VIX ETP ecosystems is my favorite example. There’s a whole cornucopia of long VIX and short VIX products and VIX itself, as you know better the name, is already a bundle of basically option prices. That complex, that VIX ETN complex, has destroyed more money than Bernie Madoff did. Whether you go long or short, overall, that has just been a massive capital incinerator for zero societal value. We don’t like talking about societal value because it gets wooly. Who am I, Robin Wigglesworth to say this Leathered ETF is dumb or this one’s smart. I don’t believe in that myself, really. I’m a nice liberal, but some of these things are just so heinously dumb. I wish a regulator would just say, “That is stupid. Nobody should be allowed to trade that. If they want to do it, they do it in a hedge fund strategy, that’s fine. You guys can blow up your own money or client’s money, but that should never, ever, ever cross into the retail space in any form or fashion”.

Peter van Dooijeweert:

I want to talk a little bit about quant because you made a comment earlier that passive is the initial quant strategy. I’ve heard you say before that you think eventually, the whole world is just going to be quant strategies and equity. Maybe I’m bastardizing your quote, but it’s something along those lines. What are your thoughts there?

Robin Wigglesworth:

Well, I mean it’s my point on that continuum and that I think there are things that humans, I mean man doesn’t have a big black box that you hit a button on every morning and then you go to the beach or go to the pub, right? There are humans involved in every part of the process. When I say quant, it’s not a human free future, but I do think that broadly speaking, there are certain things that machines are better at than humans. When I look at the active fundamental discretionary large cap equity space, for example, I struggle to see what value it adds, apart from maybe the more abstract making markets efficient, but I think quant strategy has helped doing that as well, that we have a tendency to bifurcate the world between active and passive quantum discretionary. We all know it’s a sliding scale or it gets blurred.

I do think that the future is fundamentally going to be far more quantitative with humans still playing a huge important role, but a very different role than they have in the past and it’ll be more that sliding scale where the vast majority of asset allocation will be too cheap or basically free beater. I think the price of beater in most markets is going to trend towards zero over time. It’s basically there in equities already. It’ll probably go there in fixed income over the next 10, 20 years. Then, you have a subset, let’s say 20% of the global AOM universe that is going to be essentially just investing. It’s just going to be considered investing and the whole idea of dividing the world into quantum active is just going to become a bit of a weird historical thing, like portable beater or terms that you don’t really hear that much.

That is just going to be considered good investing and bad investing and some people are good at it, some people are bad at it and I think the people are good at it are probably going to be using computers and data more than the people that are bad at it.

Peter van Dooijeweert:

Do you think the quants have space to go after privates? Are the privates, are they quaking in their boots, waiting for the quants to show up?

Robin Wigglesworth:

I do not think they are quaking in their boots. I think they are intrigued at how they can do some of this stuff themselves. I do think we are going to have a quant arc in privates as well, but obviously, it’s just such a radically different market and in the same way that people have discovered sometimes belatedly, but I think it’s well known now. You can’t just copy and paste an equity for active framework into fixed income, even though they’re both semi-public markets and fixed income privates are just very different. Fundamentally, look, there’s a quote from Jack Treynor that I love. He was the head of the CFA Institute, the CFA Journal at one point, one of the OG quants. He said, “You might not get rich by using all the available information, but you’ll definitely become poor if you don’t”. Broadly speaking, if quant means more rigorous scientific unemotional use of data to attain better investment outcomes, then yes, I think privates is going to also going to evolve into becoming more quantitative, but it’s going to look radically different than say large cap US equities or even fixed income looks like.

Peter van Dooijeweert:

I might counter argue against the private capital world having a lot of alpha, as you might expect I would, and I have lots of good anecdotes. There’s a dog walking app that was funded by a bunch of different VCs and they kept losing the dogs. Now, I would argue it’s easy to pick up the dog and walk the dog. It’s the returning of the dog that’s incredibly important to the process and they weren’t very good at that. I’ll leave that to the site. I’m not going to debate you on VC, but I guess I’m going to touch a little on that point that you made about systematic, but the idea of diversification for you’re a retail investor, you’re a pension investor, I mean everyone looks bond equity, maybe they’ve dabbled in commodities, is systematically the only place they’re going to find things like commodities, short bonds, FX, things that they just aren’t inclined to trade on their own well?

Robin Wigglesworth:

No, I mean multi-asset, I think broadly speaking, this is not a new insight. Markowitz discovered it many decades ago, but diversification is maybe not the only free lunch. There’s also a few others maybe out there, but it’s certainly an obvious one. I think if you are doing trend following in a limited set of asset classes, that becomes harder. It has been an interesting trend to see, both in existing strategies or a standalone funds, a growth of frontier market trend following, stuff like cheese prices, uranium. There are many things that trend to varying degrees and they are less correlated. Maybe in the future, we’ll be doing trend falling at NFT prices. I pray to God not, but who knows, right? There’s unlimited amount of stupidity out there, as we discussed.

Peter van Dooijeweert:

Actually, the more stupid, there’s a tendency for a thing to just go up inexplicably for a long time, the better I suppose. I guess I might just given your seat, because you see everything. I might finish up with one last question. Given the, I don’t want to call it peak breaking things here, but we’re on our way to breaking things theme we’ve had in the talk. Besides auto callables, what do you fear in this market?

Robin Wigglesworth:

I fear mostly, I mean there are many things. I worry about credit. I worry, specifically, maybe about private credit and the interaction with the private equity world. I feel that world is very incestuous. There are a lot of firms that lend and invest to each other constantly. I’m not worried about that being systemic, but I think there are issues there. That’s, maybe it’s the classics of journalist, heebie-jeebies, oh, this has grown a lot, urgo, I worry about that. You see that a lot with passive like, oh, passive has grown a lot, urgo passive is the new CDOs, essentially. Obviously, there are tons of nuances in these things. China is an obvious one. I worry about cyber. I mean, when I talk to smart people, it’s the one thing that they say, “Everything else, market’s pooping 20, 30, 50%”. That’s within the bounds of what we’ve been through”.

It’s scary and it’s horrible that it ends careers and so on, but that’s, frankly, life. Cyber is one of those things that people keep smart. People smarter than me are getting more and more worried about that. I worry about the stuff that we don’t worry about most, so the LDI thing is a perfect example of that. It’s always what you don’t worry about that bites you the most violently. If you buy junk, if you buy a high yield credit, you lose money. If that company goes bust, like that sucks, but it’s in the name. You know that and you run risk. People buy risk knowing that the risk could materialize. They might end up being more risk than reward.

I think that’s the why, for example, in ’08, what really scared the crap out of people, from my understanding, and friends that still bear the emotional scars of it. It wasn’t like CLOs keeling over or even some of the property dead. It was the triple A top tranches of CDOs. It’s stuff that you thought was super safe that you thought was completely fine. I think LDI is a good example of that. It’s not to compare those two, but it’s the stuff that we don’t even know about that suddenly comes out of nowhere and smacks you in the face. I think the Bank of England has discovered this. I very much doubt that they’ve really thought much about this. That’s the kind of stuff that’s scary. It’s not the kind of stuff that, oh, credit is cracking. Lots of companies are going bust and that might ripple into the banking sector. It’s kind of bad, but we’ve seen that before. We’ve seen that movie. We know what to do. We know how it ends this other stuff.

I think what I worry the most about is that we have been in a exceptional era for over a decade now and exceptional eras tended lead to exceptionally interesting things. We are not nearly at peak breaking moment yet. Certainly, if the Fed keeps jacking up rates by 75 basis points every meeting, then we’re going to see more than just UK LDI ticket pasting.

Peter van Dooijeweert:

Well, and then a somewhat cheerful note, we’ll finish our talk. It’s really been a lot of fun. Thanks for taking the time to join us, Robin.

Robin Wigglesworth:

No, no. Thanks so much for inviting me, Peter.

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