Animal Spirits Podcast Summary: "Talk Your Book: How to Eliminate Negative Alpha"

Podcast Information:

• Title: Animal Spirits Podcast
• Host/Author: The Compound (Michael Batnick and Ben Carlson)
• Episode: Talk Your Book: How to Eliminate Negative Alpha
• Release Date: February 10, 2025

1. Introduction to Trend Following and Systematic Investing

The episode opens with Michael Batnick and Ben Carlson introducing their guest, Cole Wilcox, one of the pioneers in trend following strategies. Cole emphasizes the appeal of systematic investing: eliminating emotional decision-making and adhering to a predefined system.

Notable Quote:

• Cole Wilcox [00:43]: "Ben I love the idea of systematic investing trend following, removing the emotion. If only I could follow it."

2. The Distribution of Stock Market Returns and Power Laws

Ben discusses the research inspired by Henrik Bessembinder, highlighting that a small fraction of stocks drive the majority of market gains. This power law distribution underpins the rationale for trend following, which systematically captures these top performers while avoiding the majority of underperformers.

Notable Quote:

• Ben Carlson [05:11]: "Most companies and most stocks are actually very, very bad investments. And a small minority are driving all of the market's cumulative return."

3. Implementation of Trend Following in Longboard Funds

Cole delves into Longboard Asset Management's unique approach to trend following. Unlike traditional multi-asset trend following strategies, Longboard specializes in individual securities within the Russell 2500 index. Their method involves holding securities that are breaking new highs and exiting those hitting new lows, effectively capturing the "cream of the market."

Notable Quote:

• Ben Carlson [09:27]: "Our investment universe is quite broad. It's the entire Russell 2500 index of US companies... we constantly just own the cream of the market through every evolutionary cycle."

4. Addressing Emotional Investing and Eliminating Negative Alpha

The conversation shifts to the psychological pitfalls of discretionary investing, such as the tendency to sell winners too early and hold onto losers. Ben underscores the importance of systematic strategies in mitigating these human biases, thereby eliminating negative alpha generated from emotional decisions.

Notable Quote:

• Ben Carlson [07:51]: "Designing strategies and systems that can eliminate the negative alpha that comes from your human failures and put it into a process like this... is why we do what we do in our strategies."

5. Handling Drawdowns and Managing Volatility

Ben explains that trend following inherently involves enduring significant drawdowns, especially with high-growth stocks. Longboard's strategy accommodates this by setting stop-loss levels adjusted for each stock's volatility, allowing for long-term trends to materialize despite short-term fluctuations.

Notable Quote:

• Ben Carlson [13:25]: "Our average hold time on a position is going to be measured in years in a highly profitable position, it's going to be measured in multiple, multiple years."

6. Comparison with Hedge Fund Structures and Alternatives

The discussion compares Longboard's trend following approach to traditional hedge funds and buffered strategies like hedged equity. Ben criticizes many hedge fund products for limiting upside potential and highlights Longboard’s ability to capture full market upswings while providing downside protection.

Notable Quote:

• Ben Carlson [23:31]: "We want absolute stability in a moment of crisis... the most reliable source of non-correlation in a market crisis is short term treasury bills."

7. Performance Metrics and Strategy Resilience

Ben addresses the resilience of Longboard's strategy across different market cycles, noting sustained alpha generation and low correlation with major indices like the S&P 500. He references their recent research demonstrating the stability of their approach and its ability to adapt to varying market conditions.

Notable Quote:

• Ben Carlson [18:11]: "Last year was actually one of the most successful alpha producing years for trend following on stocks."

8. Market Environments and Expected Performance

Cole inquires about the optimal and challenging market environments for Longboard’s strategy. Ben identifies prolonged sideways markets and extreme volatility as potential challenges but asserts that their broad investment universe usually finds positive trends to exploit.

Notable Quote:

• Ben Carlson [25:30]: "The worst environment for us is probably over the last 10 years because our universe has sucked so bad compared to what everybody thinks is the general market."

9. Fees, Beta, and Correlation to the Market

Ben elaborates on Longboard’s competitive positioning within the alternative investment space, emphasizing their low beta (~0.45) and moderate correlation (~0.5) with the S&P 500. He highlights their focus on delivering high net returns by maintaining fair fee structures and optimizing for both returns and risk.

Notable Quote:

• Ben Carlson [31:25]: "Our beta long term is about 0.45 on average... we produce a lot of positive alpha and it looks great in terms of the raw returns and the risk-adjusted returns."

10. Conclusion and How Advisors Can Engage

In wrapping up, Ben discusses Longboard’s collaboration with financial advisors, offering consulting services to optimize alternative investment portfolios. He invites interested advisors to visit Longboardfunds.com for more information and support.

Notable Quote:

• Ben Carlson [36:24]: "The majority of my time is working with financial advisors and helping them construct and optimize their alternatives portfolio."

Key Takeaways:

• Systematic Trend Following: Eliminates emotional biases, ensuring disciplined investment decisions.
• Power Law Distribution: Recognizes that a small subset of stocks drives the majority of returns.
• Individual Security Focus: Longboard’s unique approach targets securities within the Russell 2500, capturing top performers and avoiding underperformers.
• Risk Management: Adapts stop-loss levels based on each stock’s volatility to manage drawdowns effectively.
• Performance and Resilience: Demonstrates consistent alpha generation and adaptability across diverse market conditions.
• Advisor Collaboration: Provides consulting and optimized solutions for financial advisors seeking to enhance their alternative investment offerings.

For more detailed insights and to explore Longboard Fund’s offerings, visit longboardfunds.com.