1

Top Traders Unplugged | Episode #101

“Investors should know where the Sharpe Ratio is coming from and what is going to

be the expected return in an equity crisis. So, that’s critical and needs to be done

across multiple timeframes. CTAs are a great equity hedge but today they will not

provide protection if it’s a relatively quick correction. If it’s a two or three-week

correction, I would say that CTAs would have a hard time...”

~ Nigol Koulajian

The following eBook serves as a detailed transcript of Episode #101 of the Top Traders Unplugged Podcast.

You can find show notes and more information on this episode right here: toptradersunplugged.com/nigol-

koulajian-quest-partners-101

I sincerely hope these interviews serve as a useful resource for you in your career and endeavors in the world

of trading. If you have indeed enjoyed these shows, please consider giving the podcast a rating and review

on iTunes. It would help spread this knowledge to traders everywhere.

As you read this transcript, remember to keep two things in mind: all the discussion that we’ll have about

investment performance is about the past, and PAST PERFORMANCE DOES NOT GUARANTEE OR EVEN INFER

ANYTHING ABOUT FUTURE PERFORMANCE. Also understand that there’s a significant risk of financial loss

with all investment strategies and you need to request and understand the specific risks, from the investment

manager, about their products before you make investment decisions.

2

Top Traders Unplugged | Episode #101

Niels: Nigol, welcome back to the podcast. It’s good to have you here. Katy and I are very

excited to be having this conversation with you and to get a chance to do it all together here

in Miami.

Now, it’s been another surprising (and for some) exciting investment year. But also, we want

to refresh our minds, before we get started, with what has happened in-between when you

were on the podcast a few years ago. So why don’t you refresh our minds about your

development, firm wise, and maybe a little bit of background to refresh people’s minds on

your own path into this industry. Then we’ll jump into some of the exiting stuff that we can

talk about today.

Nigol: So, quickly, my background is that I studied electrical engineering and went to work for

Andersen Consulting. When I was twenty-one years old I decided to become a CTA – I had the bad idea

of doing that, but… (Laughter)

I got an MBA at Columbia. Since I was twenty-one, I’ve been teaching myself about trading

systems, and reading, and trying to speak to different professors. Again, I made the mistake of

going to Columbia Business School, which is a very equity driven fundamental investing

[program]. Basically, there I was like a leper. I felt like I was in a nudist colony or something, it

was not the right place to be as a technical trader. But it was a good experience overall.

I had a couple of stops before I could actually start a CTA. First, I ran a fund of funds for a

couple of years, and I also traded Risk. Arb. for a couple of years. Finally, in 1999, I had enough

investor interest to start a CTA.

Most of our history [Quest Partners], up to 2010, we managed money where one investor had

ninety percent capacity rights. They redeemed in 2010 and our assets dropped from six

hundred million all the way down to fifty. So, it was from 2010 to up until 2014 I was trying to

rebuild the firm.

In 2014, the firm had about seven hundred million in assets with about nine people. Between

2014 and now, we’ve grown to about 1.4 billion and now there is nineteen of us. So, we’ve

grown quite substantially, despite having a very difficult year.

So, interestingly enough, down at the conference people were saying, “How did you manage

to raise so much money by losing so much?”

Niels: Yeah, but don’t make it a habit, right? (Laughter) It might not always work out that

well. But it’s been impressive, for sure. It’s a great story to follow. It’s really good to have you

back to follow up on where we left off last time we spoke, for sure.

3

Top Traders Unplugged | Episode #101

Katy: Nigol, what are some of the things that you’ve learned along… You’ve obviously had a

very long path, and it’s been a long and interesting path. What are some of the things that you

learned that you’ve incorporated into your process?

Nigol: There’s so much… There are so many layers of learning. Every time you think you learn

something and think, “Now I have it,” and you realize that there are just many more layers -

technically, first, of course, in terms of how to do momentum trading, all of the different

aspects, the different timeframes, and the different filtering techniques.

Also, in such an extreme environment such as 2017 (in terms of where mean reversion was

such a strong component in the short-term timeframes) there were the questions of how to

deal with that type of environment, how to deal with investors, how to have a very clear

process which is as transparent as possible despite having (I would say) one of our worst

years.

Actually, it was our worst year, yet, we were able to double in size pretty much. So basically,

defining your process clearly, isolating the value added where investors know how you’re

going to perform when they look at the market (or at least they have a good sense) is so

critical in terms of providing stability to a business.

Niels: It’s interesting that you say that. You hear a lot of the sort of gurus, not just in our

world, but the successful entrepreneurs, they always tell you what you should really learn is to

fail well. And those “failures,” or the difficult times, are where you learn the most. So can you

translate that and say that 2017 was the year you learned the most? Is it that kind of thing?

Nigol: You know, I’ve been listening to Ray Dalio’s book, and he talks about failure and how

he grew out of that. To me, I’m always feeling like I’m in a state of failure. I never feel

comfortable.

The CTA industry is so up and down. It feels like it’s a constant. During the growth there are

challenges, and during the difficult periods, there are challenges. To me, although it’s very

pleasant to be arrogant and confident, unfortunately, I’ve chosen to try to live in a way that I

feel like I know nothing. I know that what I know today is going to become irrelevant

tomorrow. To build from that platform rather than saying, “Here is what I know.”

Critical in the investment process, I would say, that there is something which is… the

techniques have been known, and there are new techniques, etc. etc. But really, the critical

aspect (and what comes with a lot of years of investing) is understanding your own intuition.

It’s like you can justify every investment technique at any different time. You can say, “This is

doing great. You can buy it because there’s a bubble in this technique,” or you can say, “Buy

this because it has underperformed.”

4

Top Traders Unplugged | Episode #101

At the end, what is really important is evaluating, within yourself, where that intuition is

coming from. Typically, I think we make decisions emotionally then we justify them

intellectually. So, evaluating where the decision is coming from has been the most critical

aspect, where I would say what I can do today that I couldn’t do twenty years ago when I

started. All the techniques that I know I could teach to someone who is relatively competent,

but that aspect of the business is much more difficult. That’s the most valuable.

Niels: Yeah, you mentioned Ray Dalio. I recall from our last conversation when, I think it was

that I asked you if you would tell something or share something that most people didn’t know

about you, you told me about the fact that you do meditation, and I think even the same

meditation as Ray Dalio.

He attributes that, at least in the book (I’ve also been catching up on his latest book)… He

attributes that, actually, as probably the most important thing that he’s done in his career. Are

you at the same level when it comes to meditation, meaning that you think that this is so

critical to achieving the success that you’ve achieved?

Nigol: Yeah, I’m going to say it seems to be the more I meditate, the better decisions I can

make. So, when I feel stuck in life that’s what I do is choose to do… It’s like people say, “Let me

do this,” and they become overactive and try to reach. For me, the instinct is quite the

opposite, which is to retract, and quiet down, and start again.

The way to start again, and to see the world fresh, is to do something that my mind is not

comfortable doing. I take away from it all of its toys and to make it a little bit uncomfortable –

it’s kind of like erasing it or kind of like having a reboot.

There are daily aspects of meditation. So, Ray Dalio does TM [Transcendental Meditation]. I

started practicing TM only about five years ago, but I started meditating twenty-five years ago.

So, for me, the retreats where you go for seven days or ten days, and you’re sitting in silence,

and you have no idea what’s going to come out of your mind, these are the most useful. The

ideas that come are typically not in line with what you thought when you entered. It is only

when you quiet your mind down enough that you can allow yourself to hear what something

inside you already knows - that deeper intuition which is very, very valuable and which is more

difficult to get.

So, the important aspect of meditation, for me, is that there are different aspects of the mind

and of emotions where you identify less with them. You are able to look at them as external

things that you can use. I can choose to think this; I can choose to think that. Where, before

that, I thought that my thoughts and I were one. So, I cannot define that as something

different because I would lose - I would feel scared of changing my mind.

5

Top Traders Unplugged | Episode #101

With meditation, I’m willing to look at the upside and downside of every thought or every

emotion. Then, you can go to something which is a little bit deeper where you’re aware of

where these things are coming from. Then there are little messages there that tell you

whether you’re acting out of fear, you’re acting out of greed, you’re acting out of jealously,

you’re acting out of confusion, desperation, all these things. Then you have habitual thoughts

that come with each of these thought regimes, let’s say. Knowing what thought regime you’re

in is highly useful.

So yes, I’m going to say definitely, that coming from a, let’s say, technically slightly above

average place, I think with meditation anybody can succeed in anything that they do because

your mind becomes so malleable. I’m going to say it’s an amazing technique for no matter

what one is looking to achieve.

Niels: If it’s that useful I might consider it.

Nigol: Of course there is the stress of everyday life where we have to process so much

information, and our nervous systems are not designed to handle that much information. So,

meditation is also very useful in being able to slow down the nervous system that way.

Niels: Thanks for sharing that.

Katy: So, Nigol, I was thinking that Quest has been around for quite a while in the space and

recently, as we discussed, you’ve had quite a lot of growth in your firm. What do you think,

even though we’ve discussed performance, what are some of the success factors that you

have seen that have really helped you to build your business more in the recent years?

Nigol: So, one aspect which I’ve lived with is that I grew up in an unstable third world country.

So, I’ve seen instability, and I’m always assuming that the world is unstable. So, I’m always

looking at the tail events, and I give them much more importance than typically, I would say, a

money manager would in the US. As a result, I’m always thinking of the tails rather than

thinking of the everyday event.

The way that translates into a strategy for Quest is that we’ve always normalized our returns,

not based on volatility, or based on market beta, but we normalized our returns taking into

account tail risk. That’s something which is not typical in today’s asset management industry.

So, in today’s world, you can achieve Sharpe Ratios of five if you go short the VIX, and you can

achieve negative Sharpe Ratios depending on the market environment. All of that is available

depending on the level of convexity or tail risk that you’re willing to expose yourself to.

6

Top Traders Unplugged | Episode #101

So, convexity is basically like when you’re driving a car, as you’re approaching a wall, whether

the investment strategy is going to accelerate or be able to slow down. Negatively convexed

strategies are strategies where, once you start losing, your loss is going to accelerate. It’s

typically difficult to get out, such as a short VIX where you’re making money almost every day,

but then when you lose you can lose six months, one year, three years, five years of returns.

So, negatively convexed strategies are ones where there is acceleration when you’re losing

and positively convexed are when there is acceleration on the upside. What we see is that, in

the same way, there is CAPM with S&P correlation and S&P beta, we use a CAPM which is

convexity based. So, we’re looking at skew as the driver of alpha and skew as the driver for

Sharpe Ratio.

As a result, where a lot of investment managers have gone from aiming for higher Sharpe

Ratios by exposing themselves more and more to risk on; or more and more to negative tail

risk or to being short the tails, or being short puts on S&P type of thing; we’ve maintained a

discipline where the alpha that we’re looking to generate to the S&P or to the CTA index has

to always come with positive convexity.

What I’m saying is that you can easily increase your Sharpe Ratio or easily increase your alpha

to the indices by shorting tail risk. I would say that’s not a skill based return or skilled based

alpha.

By making the differentiation, we’ve been able to pick aspects of the market where there are

very serious inefficiencies. What percentage of investors, today, looks at the realized

convexity in the markets? Most people look at realized volatility. That’s how they size their

positions.

We have found that there are ways to effectively, without trading options, go long options; or

trade in the direction of potential volatility increases in the market when you measure realized

convexity. That’s been extremely valuable. So, we’ve generated very high alphas to the S&P

while being long a put at the same time. That’s the value of what we’ve done from a message

perspective and from a strategy perspective.

Niels: Is this something that you can do, but it has to be done in a particular timeframe

because, obviously, what you’re explaining (if I understand it correctly) is certainly different to

the traditional trend follower who typically dominates the managed futures space. So is that

why you’ve also… Is that what’s leading you to focus, also, on a particular timeframe in order

to deliver that?

Nigol: Yes, so in general, and in the past twenty years, the more long-term you’ve been, the

less positive convexity you generate. So, how have CTAs hedged S&P corrections or equity

corrections? Mainly from being long fixed income, or from trading short-term. Effectively

7

Top Traders Unplugged | Episode #101

trading long-term, it will take you… In today’s world let’s say the S&P goes down (I know that

would be miraculous) but let’s say the S&P starts to go down, it would take a long-term trend

following strategy, such as a three hundred day moving average—which is, call it, an eight

percent correlation to the CTA index—it would take it weeks to reverse from long the S&P and

short fixed income to the other way.

So, let’s say the longer-term CTAs today have reduced… By becoming more long-term and

adapting to what has worked, they’ve reduced their ability to hedge S&P corrections. So, more

short-term, more shorts, typically in today’s world give you more positive convexity. If you

assume fixed income is gone as a negatively correlated asset to the S&P, let’s say today…

Niels: The amplitude of the move would be…

Nigol: Right, today I would say half the fixed income markets are short momentum. If you

look at the 5-year, the 10-year [U.S. Treasury Notes], so you’re already seeing some bear

markets in fixed income. If the S&P goes down CTAs could potentially lose both on the reversal

on equities and on the reversal of fixed income. Where, when you’re trading a shorter-term

timeframe (where we found that the ideal level of convexity comes up around seven to ten

days per trade) you’re able to have more positive convexity and enough returns and enough

alpha where you’re not becoming too sensitive to mean reversion. So, that seven to ten [day

timeframe] is very critical.

Katy: Just as a follow question, you mentioned timeframes. It seems like you’re incorporating

this philosophy in pretty much risk management, signal construction, strategy selection. Is

there any aspect that you think is the most critical?.

Nigol: You can do the same thing in your models. You can do it in your risk management. We

choose to do it by adding models. Our risk management is very, very flat.

The way our positions increase is by getting new signals that are diversified from the previous

ones. But you get equally… say that my models are very simple, and my risk management is

going to handle this, which it will do at a system level, but you need to handle it somewhere.

So, when you trade more short-term, you have to become more filtered because you become

more transaction cost sensitive. Where you can trade long-term and be one hundred percent

in the market long or short. The more short-term you go, the more selective you have to

become in your trades to overcome transaction costs. So, you’re going from a long-term

strategy where your slippage is five percent of your gross profits to a short-term strategy

where your slippage is thirty, forty, fifty percent of gross profit.

8

Top Traders Unplugged | Episode #101

Katy: So, less continuous signals and maybe more pure conviction driving convexity.

Nigol: Correct. That’s right, especially when you’re looking for the accelerations we are saying

that you need to jump in before the acceleration comes. Of course, you can do this, if you’re

trading mean reversion you can trade short-term very, very, easily. We’ve provided models in

our research that have Sharpe Ratios of three, four, five, just buying the dips in financials.

That’s very easy, and we provide those models on our website.

Katy: So, Nigol, I have to admit I’m a fan of a lot of your white papers. I think I’ve read them

all. I think one of my favorites was the one on long bonds, and also you had one on equity bias

a while ago as well. What is one of the most recent and most interesting white papers that

you have written? And, do you have any in the pipeline that you can tell us about? I am

looking forward to reading them.

Nigol: We haven’t written much because we’ve been busy digesting the assets that we’ve

raised. But, I think the next one that we will write will be about creating a CAPM linear model

between Sharpe Ratio and alpha and convexity. Telling investors, effectively, before you

evaluate the Sharpe Ratio of an investment you need to look at the convexity. Providing actual

linear equations saying that, for a convexity of minus two you should achieve a Sharpe Ratio

(in this environment) of one and a half, and if your manager is not achieving higher than one

and a half effectively, you can replicate him.

So, the next paper will focus on, not only that convexity tells you how much you can lose: how

many multiples of volatility your drawdown is going to be; but you can also predict what the

Sharpe Ratio and the alpha to the S&P and to the BTOP are going be as well.

We’ll soon write a paper which actually will illustrate that relationship more clearly so that

investors are, especially in a world like today where the vol. is low, and the risk is really in the

convexity, not in the volatility, investors can continue to evaluate whether the managers that

they are allocating to and the markets that they are allocating to with that in mind.

To us, that’s the most important aspect of risk where risk is overlooked, but also the alpha and

the upside might be… The expectation on those can be misconstrued.

Niels: So, does this kind of… These are technical explanations, and I certainly find, in my work,

that if I make it too technical, I lose people. On the other hand, your strategy, your argument,

to me, appears to be suited well for a technical explanation because you probably want to

appeal to a certain audience and be part of or serve a very specific role in their portfolio. So,

do you find that doing these white papers and making it a very technical argument, does that

9

Top Traders Unplugged | Episode #101

help you, not just raise assets, but also build that relationship during the difficult times with

investors? Do they understand it? Do you think they understand?.

Nigol: I’m going to have to generalize here, but when our assets dropped to like fifty million in

2010, we typically heard, “You’re going to have to start with the high net worth individuals,

then go to fund of funds, and then maybe later you can talk to pensions.” In our case, it was

exactly the opposite.

When we were the smallest, it was the biggest, most sophisticated pensions that were

allocating to us. Now that we’re growing and we’re over a billion, we’re having more fund of

funds and high net worth individuals come and ask us questions.

So, definitely, these papers created a common language and addressed the fear that some of

these pensions had in their hedge fund portfolios and their equity portfolios. So, expressing

that using a clear technical method was, for us, was a necessity. It was like having a common

language. If you don’t have that, it’s very difficult to communicate with your investors.

Niels: What you’re saying here now is that you’re actually of a size, and you’re getting a

different audience who come to you because maybe they are afraid that markets will, at some

point, have a correction. I love the stats you give out every month and all the records that we

can borrow because we’re too lazy to research them ourselves. You do all that work, so that’s

great. But, do you think you have to now start explaining it to a different audience in a

different way? Maybe we can try that today: if you were going to explain this to an individual

investor, what exactly is it that you… Why should they consider you to be part of their

alternative portfolio?

Nigol: I don’t think I can explain that, but I’ll try!

Niels: It’s a good rehearsal!

Nigol: So the way to look at it is that people are used to the market as something where the

risk is visible. It goes up, it does down, and then you try to remember, when it went down,

how much did it go down? Is it five percent, ten percent, fifty percent? Typically, investors

think of risk in those terms.

Now, what we’re seeing is that the market has gone down, or has had such little volatility. At

the same time, if it starts to go down, the market is going to go down substantially. This is not

something which is visible in price.

10

Top Traders Unplugged | Episode #101

If you look at the option pricing, puts are priced at twenty, twenty-five percent, thirty percent

implied vols., where the calls are priced at seven, eight percent implied vol. So, if you look at

the price, you have no idea what is going on.

Effectively, if you look at the market in terms of the skew index, for example, it will tell you

that if the market starts to go down, it’s going to have a very, very big move. So, the way I

would explain that to a more high net worth individual is that you can sell insurance, make

money every month, and think that you’re invested in a very, very high-quality manager when

you are not. All you have done is sold something where the risk of loss is very, very small, but

then the size of the loss is going to be very large.

So, in terms of selling insurance and buying insurance; or buying Lotto tickets, or selling Lotto

tickets, investors do understand that there’s a cost of carry where people want the positive

convexity, in general. So effectively, we’re saying that with convexity you have to think of it as

you would Lotto tickets or as you would selling insurance. Today, most financial assets look

like they’re selling insurance rather than being long. This is, typically what we refer to as

equity beta. The risk in equity beta is very, very small - immeasurable I’m going to say.

Niels: So, when you do that, are you taking up the case against that it’s the convergence

versus divergence strategy? It’s not so much actually against other CTAs it’s just the fact that

most money, as we know, is invested in other strategies. It’s not invested in trend following;

it’s not in managed futures, it’s actually the fact that they have most of their current assets

invested in strategies that may be much more risky than what they think.

Nigol: Correct. The risk is not measured. So, CTAs have done the right thing for most

investors. They’ve improved their Sharpe Ratio by converting their positive convexity into… by

combining risk on and off or convergent and divergent. They have improved their Sharpe

Ratio, but they probably will not provide as much protection during equity corrections as a

result.

It’s not a question about whether it’s good or bad, it’s just a question that investors should

know where the Sharpe Ratio is coming from and what is going to be the expected return in

an equity crisis. So, that’s critical and needs to be done across multiple timeframes. So, CTAs

are a great equity hedge, but today they will not provide protection if it’s a relatively quick

correction. If it’s a two, three-week correction, I would say that CTAs would have a hard time

providing [protection].

So, it’s just a question of transparency that convergence and divergence are different in

different timeframes. So, you can choose to be divergent in the longer-term timeframe,

because that’s still available today, and it’s not costly. But, it’s very difficult to be divergent in

the shorter-term timeframes because mean reversion has been the driving factor when you

look at short-term moves.

11

Top Traders Unplugged | Episode #101

If you explain that to investors, I think (in my mind), they understand your returns better

considering the market environment. I think you also gain clarity on your own process. You are

able to trade convexity neutral in individual timeframes, in individual sectors.

Rather than it being momentum, you can say I want to be long/short momentum. I want to be

one hundred and thirty percent long momentum and thirty percent short momentum. And I

can say that I can be momentum to mean reversion neutral in every time frame in every

sector if I want.

So, those types of decisions can only be made when you have enough clarity to look at it in a

way that the risk is truly measured in terms of convexity. This is not available, so sometimes by

trying to please investors in the short-term would diminish our long-term possibilities.

Katy: So, continuing with that, Nigol, turning to the short-term space, we’ve seen that the

short-term space has been challenging since, I think since about 2010. It’s been a rough space.

Nigol: You’re being very kind!

Katy: Given that you’re an expert in this space, what have you been doing to adapt to it?

What’s been happening? I would love to hear your views on that?

Nigol: So, the short-term index is flat since inception, or negative or actually down since

inception. So yes, "challenging" is, as I said, you’re being extremely gentle.

So, why are short-term managers still getting allocation? This is because of diversification, but

also because of convexity. If you’re long a put on the market and it’s going to cost you ten

percent a year, fifteen percent a year, twenty percent a year, you can get the same protection

for five percent a year negative. Investors who are pricing these things accurately will see a

great investment.

So, lucky for us, we’ve been able to provide substantial alpha relative to the CTA indices,

whether short-term or long-term. So, in the short-term space what’s critical is that the short-

term space is much more easily crowded. When you’re trading short-term, you’re typically

trading more stops and trading on stops intraday rather than VWAPing (Volume Weighted

Average Price) or trading market on open, market on close.

So, you’re very sensitive to spikes in the market, up or down, and you’re getting whipsawed

much more if you have short-term noise. So, what’s critical to do then is to have the right

filtering techniques.

12

Top Traders Unplugged | Episode #101

Of course, you want to buy cheap convexity, and you want to sell expensive convexity,

realized in the markets. One way to do this is, if everybody is trading a ten-day channel

breakout, you want to short ten-day channel breakout.

If you look at the short-term CTA index, you can have seventy percent correlation to it by

trading ten-day channel breakouts. I know short-term CTAs are much more short-term than

that, but ten-day channel breakout I think has seventy or eighty percent correlation.

So, this is kind of like the smart beta version of the short-term CTA index. You want to be

shorting that and going long momentum around it. So, if everybody wants to buy the S&P,

nobody wants to buy stock number five hundred and one, short the S&P and go long small

cap. It’s typical arbitrage of equity long / short.

The same thing applies in the CTA space. You want to short smart beta and go long everything

around it. In the short-term space, in particular, where you’re highly affected by the liquidity

of the markets this becomes very, very critical. So, there are ways to trade mean reversion

where it’s kind of like the “lazy man’s trading,” where you want to find the positive convexity

around it, the same as I explained with the S&P.

Niels: Just curious, maybe on a slightly different tack. You bring up the words “smart beta.” Of

course in our industry, and in particularly the trend following space, over the years it has

been… Certain firms promote trend following as being a very easy risk premia to replicate, so

they sell their products very cheaply. Yet, I have not really seen that these products have

outperformed the true veterans in that particular strategy.

I’m just curious, but the smart beta products, some of them, have raised billions of dollars

because people look at the fees and say, “Oh yeah, it’s easy so we shouldn’t pay so much for

it.” So when you say you should short beta and do everything around it, what should you then

do? I’m curious whether, in fact, is smart beta (and I’m referring to trend following because

it’s easy for me to understand), is smart beta overrated in some ways? That it’s maybe not as

effective in capturing that risk premia in some ways?

Nigol: It’s very effective when nobody has money in it.

Niels: Right, OK!

Nigol: The issue with smart beta is that with transparency comes a certain amount of decay.

So, although you have multiple firms, each firm is managing three, four, five billion smart beta

type of products; or AQR is managing, I don’t know, fifteen or twenty billion, the returns were

great just prior to them raising the money.

13

Top Traders Unplugged | Episode #101

So, take an AQR replicator: let’s say you use twelve-month momentum, six-month

momentum, three-month momentum in combination, you end up with like an eighty-five

percent correlation. But then you see that, relative to that basic replicator, once they actually

raised the assets then they had substantial decay in performance relative to their own

replicator.

So, what I’m trying to say is that although it seems that individual CTAs are trading one, two,

three, four, five percent of volume, or ten percent of volume VWAP, and very gentle, and

making markets. Still, markets are heavily influenced by CTA trading. At the points where

liquidity is required, there’s not that much liquidity [where they are trading].

CTAs are a very big percentage of volume in the market. It’s easier to see that, trading short-

term, saying to yourself, “How are my assets influencing my slippage,” (or that type of thing)

and seeing what type of influence you have.

We’re trading one or two percent of volume or three percent of volume, but I think we still

have impact. Analyzing the impact on short-term and then going and applying the same

techniques of analysis to longer-term, you’re saying that the same exact thing is happening to

long-term trading where you’re running hundreds of billions.

So, going back to smart beta, smart beta is great when nobody has money in it. The more

assets that come in, the more those specific entry points are going to be affected… those entry

points are going to become counterproductive.

So, trend following works. I can give you that as a general statement, as a technique, because

it captures something that individuals or investors don’t want to do which is trade…

Niels: Buy the high and sell the low which intuitively feels weird.

Nigol: Correct. The natural thing for human beings, whether in kindergarten, whether in high

school, whether you go to business school, everybody teaches you to buy low and sell high.

Nobody wants to do the opposite.

So those psychological biases are why trend following (which is a technique which is cyclical in

return, it’s definitely not a straight line) sometimes works and sometimes doesn’t. But, when

people believe in it, it stops working because assets influence it.

This is a very, very big factor that you cannot look at smart beta outside of this factor. It’s not

that investors are coming in because there was a run in return… I don’t believe it’s purely a

timing issue, like coming in 2009. I believe that the assets coming into a strategy are having a

14

Top Traders Unplugged | Episode #101

major impact. That’s my opinion based on what we’ve seen in the short-term space and,

again, applying the same things to long-term.

Niels: Just staying with that a little but because now you’re talking about industry, capacity,

and so on and so forth, what about the short-term space in itself? Where do you think that

some of the techniques that you use... You say one or two percent of volume, but even with

that, you can see the footprint. Where is enough, enough, in your space? (Not to end up in the

same place as all the ones who have sold smart beta, but are not delivering for their clients.)

Nigol: So the death of channel breakout… Let’s say the Turtle system (buy at fifty day high,

sell at fifty day low sort of thing, with a shorter-term stop loss) came when the model went

public in the late ‘90s early 2000s. Those models had straight-line equity curves and flat lined

in the 2000s.

Then longer-term techniques such as those typically used with moving averages and

exponential moving averages, flat-lined later in 2009. So, in the short-term space—let’s say

things more similar to vol. breakout—flat-lined, definitely, since 2009 when the vol. has been

low. But they were, with filtering… let’s say the smart beta in short-term, that was dead that

long, long time ago.

Using certain types of filtering you could still survive and make alpha. Then it became

extremely… the more the vol. compressed, the more difficult in became. I would say, short-

term smart beta is dead, long dead, and as a matter of fact you can trade against it which is

what all those mean reversion models that you see today are…

Thanks for tuning into Top Traders Unplugged!

Ready to learn more about the world’s Top Traders? Go to TopTradersUnplugged.com and signup to

receive the full transcripts of the first ten episodes of the show, and visit the show notes where you

can find useful links to other amazing resources.

We have some amazing guests lined up for you, and to ensure our show continues to grow; please

leave us an honest rating and review on iTunes. It only takes a minute, and it's the best way to show

us you love the podcast.

We'll see you on the next episode of…