Summary of Episode #458: Bob Elliott, Unlimited Funds – A Macro Masterclass

Released on December 7, 2022, on "The Meb Faber Show" hosted by The Idea Farm.

Introduction

In this episode of The Meb Faber Show, host Meb Faber welcomes Bob Elliott, CEO and CIO of Unlimited Funds, a firm leveraging machine learning to replicate alternative investment returns. Bob brings a wealth of experience from his tenure at Bridgewater Associates, one of the world's largest hedge funds, where he led Ray Dalio's research team and served on the investment committee.

[00:39] Meb Faber: "Given the volatile macro environment today, we figured there's no one better to have on the show to share his view than Bob."

Current Macroeconomic Environment

Bob Elliott delves into the prevailing macroeconomic conditions, emphasizing the interplay between rising interest rates, persistent inflation, and the strength of the US Dollar.

Inflationary Cycle

Bob outlines the current inflationary cycle, likening it to historical periods like the 1970s but with modern twists such as the end of the long-term debt cycle and shifts from globalization to deglobalization.

[04:22] Bob Elliott: "I'm basically going back to core cause effect relationships, understanding those cause effect relationships and from there putting into context... to predict what's going to happen and then compare that to what's priced into asset markets."

Labor Markets

He highlights the resilience of the US labor market, noting secular lows in unemployment and the slow response of tightening measures to permeate through the economy.

[27:20] Bob Elliott: "Most people are going to say, well, isn't the labor market the most lagging indicator of the economy?... In inflationary cycles, you have not a credit problem, you have an income problem."

Beta vs. Alpha in Investment Strategies

The conversation shifts to the traditional 60/40 portfolio and its recent underperformance, especially in 2022. Bob argues that while beta has become increasingly accessible and low-cost, alpha generation remains a critical component for achieving superior returns.

Beta is Almost Free

Meb emphasizes that building a low-cost, diversified beta portfolio is more achievable than ever, with global market portfolios available at minimal fees.

[07:52] Bob Elliott: "Beta is a critical component of any strategic portfolio... but what's been my focus is figuring out how can I go beat markets."

Alpha – Generating and Diversifying

Bob advocates for diversified alpha strategies to enhance portfolio returns. He criticizes the high fees associated with traditional hedge funds and underscores the importance of systematic, low-cost approaches.

[55:00] Meb Faber: "Rather than doing what they should be doing is looking for diversified Alpha."

Diversification and Real Assets

A significant portion of the discussion centers on the necessity of incorporating real assets like gold and commodities to buffer against inflation and geopolitical risks.

[15:02] Bob Elliott: "These sorts of assets... don't necessarily have to make up the vast majority of your portfolio. Like you get a lot of diversification and a lot of protection, incremental protection from allocations like 10%, say 10% to gold or 10% to commodities."

Meb concurs, highlighting the underutilization of these assets among investors.

[18:48] Bob Elliott: "A lot of people... have constructed portfolios having lived through an experience of the last 30 years that has been the single greatest period for 60/40 portfolio and haven't recognized the unusualness."

Unlimited Funds' ETF - HFND

Bob introduces HFND, Unlimited Funds' new ETF designed to replicate the returns of diversified hedge fund strategies at a fraction of the traditional cost.

Concept and Strategy

HFND aims to provide investors with hedge fund-like returns without the exorbitant fees (2% management fees and 20% performance fees) typical of hedge funds. Instead, it offers exposure through low-cost index ETFs and systematic, machine-learning-driven positions.

[62:39] Meb Faber: "Bob is now in the ETF game with you guys... an ETF wrapper... How to replicate that?"

[75:43] Bob Elliott: "Our goal being we can provide investors a product that looks to replicate basically the gross of fees returns of hedge funds... and charge, you know, 95 basis point management fee."

Implementation Details

HFND leverages machine learning to analyze daily hedge fund performance data, inferring the most likely portfolio exposures based on observed returns. The ETF maintains a diversified set of long and short positions across approximately 50 liquid asset markets using low-cost index ETFs.

[80:51] Bob Elliott: "We're using constructed indices which cover basically all 3,000 plus funds... replicating an index rather than trying to pick."

Approach to Systematic Alpha

Bob contrasts discretionary and systematic alpha strategies, advocating for the latter due to their transparent, replicable, and scalable nature.

[56:56] Bob Elliott: "Discretionary alphas are painfully impossible to evaluate... systematic alpha managers... easier to manage from an allocator's perspective."

He stresses the importance of diversified alpha to mitigate the inherent uncertainties and volatilities of individual strategies.

[66:20] Bob Elliott: "If you can get access to the best managers, you basically say, well, you know, what you see is like, what's the right answer? It's like kind of all of them."

Future Plans

Unlimited Funds plans to expand beyond hedge fund replicating ETFs to include other 2 and 20 asset strategies such as private equity, venture capital, and private credit, all within low-cost, tax-efficient ETF structures.

[91:16] Bob Elliott: "We're trying to bring to market a set of... diversified low cost index style funds, ETFs that provide the everyday investor with the types of returns and exposures that you typically get in holding 2 and 20 products."

Bob Elliott's Investment Philosophy

Throughout the episode, Bob reiterates his commitment to diversification as the cornerstone of successful investing. He shares personal anecdotes from his early career, emphasizing lessons learned from risky trades that shaped his systematic, diversified approach.

[97:45] Bob Elliott: "I believe that the key to success is diversification... There's so many the value of diversification. Diversification is certain, edge is uncertain."

Conclusion

Meb Faber and Bob Elliott conclude the episode by discussing Bob's favorite macroeconomic indicator—initial claims—and the potential long-term impacts of persistent inflation on investor psychology and economic policy.

[96:30] Bob Elliott: "If anyone follows me on a regular basis? Initial claims. I love initial claims... it's at the critical juncture of all of the different dynamics that are going on."

Bob encourages listeners to follow his insights on Twitter and subscribe to Unlimited Funds' newsletter for ongoing macroeconomic analysis and investment strategies.

Notable Quotes with Timestamps

• Bob Elliott on Inflationary Cycles:
  “I'm basically going back to core cause effect relationships...”
  [04:22]

• Bob on Diversification:
  “I believe that the key to success is diversification...”
  [97:45]

• Meb on Beta and Alpha:
  “If you're going to charge more... you better be doing something different.”
  [10:56]

• Bob on HFND Strategy:
  “We're trying to do essentially what Vanguard revolutionized... to bring that to the world of 2 and 20.”
  [75:43]

Key Takeaways

1. Current Macroeconomic Landscape: Persistent inflation and a strong labor market signal an ongoing inflationary cycle, necessitating strategic portfolio adjustments.
2. Beta is Accessible: Low-cost, diversified beta portfolios are more attainable than ever, but solely relying on beta may limit returns.
3. Alpha through Diversification: Incorporating diversified systematic alpha strategies can enhance returns and mitigate risks, especially when combined with real assets like gold and commodities.
4. HFND ETF Innovation: Unlimited Funds' HFND offers a scalable, low-cost alternative to traditional hedge funds, democratizing access to diversified alpha strategies via ETFs.
5. Investment Philosophy: Emphasizing diversification and systematic investing can provide resilience and consistent returns in volatile markets.

Further Resources

• Unlimited Funds Website: unlimitedfunds.com
• Bob Elliott on Twitter: @BobE_Unlimited
• Learn More about HFND ETF: Check the latest information on Unlimited Funds' official website.

This summary captures the essence of the conversation between Meb Faber and Bob Elliott, highlighting the critical insights shared about macroeconomic strategies, the evolving investment landscape, and innovative approaches to alpha generation.