Stig Brodersen 01:06
Niels, I wanted to start the episode off with a story that I think is very telling, whenever it comes to today’s topic of trading and trend following. You’re one of the few people who has interviewed the famous commodities trader, Richard Dennis, and to set the scene for the interview, could you please tell the audience more about who Richard Dennis is, and specifically the legendary story of his turtles.

Niels Kaastrup-Larsen 01:13
Richard Dennis is a legendary futures trader, who worked in the pits of Chicago back in the 1970s and 1980s,  and who reportedly turned a few thousand dollars into $200 million over a decade or so. But what’s really fascinating about Dennis is that despite his own trading success, he actually believed that what he did could be taught. 

Now, as you mentioned, Dennis is a trend follower in his approach to investing, which really means he’s looking for big breakouts or momentum in the price of a market. And in his case, he was trading futures to identify potential big move up or big move down. And not only that, he was a systematic trend follower, meaning that he had rules for what would essentially constitute an entry point, as well as an exit point of any of the trades. 

He was also a firm believer that emotions are investors’ worst enemy. I think many of us will know that to be true. Because he had overcome this fact by using a rules-based approach, he believed that you could teach it to other people and that you did not need to have any special background or skill in order to be successful, as long as you could do one thing, and that was follow the rules. 

In 1984, he established the first of two classes of students. I think there were like 15 or 20 [students] in each of these classes, and they are the ones that became known as “The Turtles.” Essentially, he taught them for two or three weeks some simple rules before he would let them trade his capital, initially, using those rules. And then later on, they adapted and improved upon these rules. To make a long story short, the Turtle Project was a big success. Over the four years or so that it ran, my understanding is that the turtles did really well for Richard Dennis. 

03:29
And actually, early on in my own career, I worked for perhaps the most successful turtle, namely Jerry Parker. For those who listened today, who are familiar with my own podcast, they will know that I’ve done many episodes with Jerry. Also, as you said, I’ve been one of a few people who have had Richard Dennis on the podcast, but I think what made it really special was that he was joined by two of his original turtles.

I’ll finish this little turtle story by saying that there’s been a lot of speculation surrounding the story, because Richard Dennis had a business partner back then called Bill Eckhardt. Allegedly, they had different opinions about whether you were born a good trader or whether it could be taught. Kind of this nature versus nurture experiment. 

For decades, a lot of people talked about how they had made a bet. That this whole bet was inspired by the movie that came out around the same time called Trading Places with Eddie Murphy. But, at least, Richard told me, when I spoke with him that there never was a bet, and certainly, it had nothing to do with any movie. In fact, he shared that he thought of the experiment on a Sunday afternoon while drinking some Johnnie Walker Black.

Preston Pysh 04:46
Niels, you are talking about rules-based and that this could be taught. Could you talk about whether the most successful trend followers change the rules? If yes, how often? Talk to us about this idea of changing the rule set because I would think that that’s probably something you don’t want to tinker with if you get something that’s working.

Niels Kaastrup-Larsen 05:07
I think the best way of talking about this is maybe using a concrete example from the firm that I work for. At DUNN Capital, we are actually one of the oldest trend following firms in the world, having been around since 1974. You could say for sure that we’ve been through a number of different market cycles. The challenge you have as a rules-based manager is every time you make a change, there is a risk that you are going to get it wrong. 

First and foremost, I would say in our own case, we very rarely make meaningful changes to the system. In fact, I would go on to say that from 1974 to about 2006, we didn’t really make any major changes at all. Returns were strong, and they came with a healthy dose of volatility. But all clients were okay with that, so there’s really very little reason to change something, as you say, that was already working. If it ain’t broke, don’t fix it. 

However, what has led us to start evolving this strategy in the past 20 years or so was really the recognition that trend following is a really hard strategy for most investors to hold on to, because returns are lumpy. This means that we tend to make money in very few months of the year, and we tend to have more losing months than winning months. But of course, the reason why it works is that when we do have strong performance, it’s much more than the typical sort of losing month that we have. 

Now, most investors, frankly, prefer the steady return stream like Bernie Madoff produced until it was clear that it wasn’t real returns. So, I think they’re used to saying something along the lines of, “The seduction of safety is often more dangerous than the perception of uncertainty.” I think that’s really true, when it comes to investing. 

Niels Kaastrup-Larsen 06:59
To answer your question, we’ve made about three or four major changes, when we come across some really important discoveries. A lot of it has been to do with how we manage risk and how we get out of trades. Because actually identifying a trend, and I’m sure many of your listeners will know this, is not that hard. Frankly, you could almost do it with the naked eye looking at a chart. 

It’s much harder to figure out how much to risk on a trade and also during the lifetime of a trade, should you change your exposure. And also, when is the trend coming to an end? So those two things, in my opinion, at least, have always been the weakness of trend following. 

Our losses tend to happen when they’re either no trends or when there are big reversals in the markets, so we’ve worked very hard to find ways to improve that. Because if we can improve on this, what you’ll end up with is better risk adjusted returns, and you could say that the journey we’ve been on at least is really to try and deliver trend following in a better package.

I think a lot of people forget actually that investing in stocks, for example, is a kind of an 8% return strategy, but with 50% plus drawdowns from time to time. And we really want to do better than that. But let me also stress, that we’re very humble about the markets, and we’re still students of trend following. 

There’s always ways to improve what we do, and I think it was Leonardo da Vinci, who was quoted for saying that, “Simplicity is the ultimate sophistication.” That’s really what we’re trying to do: create something that is simple, but not too simple. It should handle the complexity of global markets.

Preston Pysh 08:50
It sounds to me like you somehow figured out a way to apply the Kelly criterion to the way that you’re looking at the trends, and saying, “Hey, this is one that we need to put more money on or more position size on because the trend is so strong, relative to these other investments.” Is that an accurate characterization?

Niels Kaastrup-Larsen 09:11
I think that’s a pretty good characterization. Absolutely. I think the challenge is that, as you say, you want to build confidence in your position to those things that turn out to be a really strong and long-lasting trend. At the same time, you want to be able to get out of those positions that obviously, if one doesn’t work from the beginning, but also, when you have been in a trend for a while and suddenly things change, you want to get out quickly. And I think the challenge we’ve had as trend followers is that the old style of trend following or the original style of trend following was to get in slowly and get out slowly. That’s kind of how it worked.

Going back to my initial point about why we didn’t change a lot from 1974 to the early 2000s was because the trends were pretty long. That kind of timeframe worked really well. In fact, we’ve done a study on our site, where we go back to 1990, and we look at what would have been the absolute perfect timeframe in terms of what we call “The Look-Back Period” for our trend model. Also, we look at each year to see whether that would be 20 days or 200 days or 300 days. Really a wide range of possibilities. 

10:27
What you see is that it changes dramatically from year to year. Just from recollection, in 1990, I think the best look-back period was only 20 days, like three weeks, which is very short term. Then the next year, it was 40 days, which is twice [as long]. And then, in 1992, it was 260 days, right? 

You get this massive, wide range of possibilities. And one of the things we have done in our firm, which is really hard to do, I think, but something we cracked in around 2006, is to completely systematise how we select these timeframes inside the model. That I would say is one of the game changers for us, because we don’t want to have any kind of discretion in the system. 

As soon as you do that, you can forget about all your research and backtest. You have to trade what you test and test what you trade. There’s no in between, but it is definitely a challenge. And as both of you know well and your audience, markets keep evolving. I think this year, we’ve seen that we’ve had the quickest sell off in history, so it’s a continued process to evolve.

Stig Brodersen 11:36
One of the things that we want to talk to you about is one of the billionaires that we follow here on the show. He is Ray Dalio, and we cover his thoughts here multiple times on the podcast about the holy grail of investing, which is having 15 uncorrelated assets, because the idea is that it will provide the best risk-to-return ratio. Having you on this show now, I think is very interesting, because we haven’t really been covering trend following like that before. How does trend following play into this thesis?

Niels Kaastrup-Larsen 12:08
First, let me say that I actually really like the way Ray Dalio explains the benefit of diversification and how this can really be a game changer for a portfolio if as you said, Stig, you can find truly uncorrelated assets. And this is where the trouble starts, right? Because many of the so-called alternative investment strategies that people have been told can be a “hedge,” when equities go down. They have shown to be much more correlated and especially during a time of crisis. 

To answer your question, the reason why trend following on a diversified portfolio of markets, meaning both financials and commodities, is so powerful to include in a portfolio of stocks and bonds is because generally, it’s not correlated at all with stocks and bonds in the long run. 

So again, if I think of our own experience, since 1974, our correlation to the S&P is -0.05, which is essentially zero. And that’s ideally what you want. But what is important to understand is that it doesn’t mean that we have zero correlation all the time. We can be positively correlated, when stocks go up. We can be negatively correlated, when they go down. It’s not a fixed correlation. 

The other thing that I have come to appreciate over the years is that the key thing to understand is that non-correlation is probably more important than excess return. This means if you can find an asset that gives you a slightly better return than your stock portfolio, but is highly correlated, it won’t do as well as picking a non-correlated asset, even if it gives you a slightly lower return. And I think this is quite counterintuitive to people.

14:00
Speaking of this, I came across a study a few years ago, where the author had essentially created a million random portfolios with different weights to traditional assets, including trend following. And one of the things they had tried across these 1 million iterations was to see if an allocation of 30% to trend following would increase the overall portfolio of risk-adjusted return. 

And can you guess, how many cases improved the risk-adjusted return with a 30% allocation to trend following? It was in all 1 million portfolios. This is obviously really interesting to me. And also, at least from my experience, I’ve never come across a white paper that suggests that adding trend following to a portfolio of stocks and bonds won’t be beneficial in the long run. 

To answer the other part of your question, so you have diversification in your portfolio, which is really important. But what about the diversification inside the trend following portfolio? How does that play into it? And I would say that that is equally important. In fact, I would say it’s vital because a lot of people think that the secret sauce to trend following is the rules: where to buy and where to sell. 

But frankly, a lot of people unfortunately end up saying, “Okay, I’ll just do trend following on my stock portfolio.” But trend following on a single sector or a single market may not work for a long period of time. The secret is that you trade it on many truly different markets. In our case, we have commodities like grains and energies and metals and meats and [softwares], in order to deliver these attractive returns. 

Niels Kaastrup-Larsen 15:39
Now, here’s the downside to this, and that is the challenge many managers come across, and that is, if you want to grow your business really big, then at some point, these smaller markets, these commodity markets, which are the least correlated in your portfolio become too small for you to have a meaningful allocation to them. If you’re tempted to kind of overstate your capacity to build your assets, then actually your returns most likely will be lower over time. And that I think has hurt our industry to some extent. 

The other thing, which is super interesting, and is something that I also came across recently because of what’s happened this year, is when you go back and you look at crisis periods. Also, when you look at your portfolios, and you look at various different sectors that you have in your portfolio, we all think about crisis as equity market crisis. 

I think it’s very tempting for people to believe that because trend followers can go long and short, that we can make a lot of money from the short side in equities, when they have like a 35% drawdown. But actually, what you find is that the most consistent performing sector, going through all of the crisis we’ve had in the last 40 or 50 years, is commodities. And this is, of course, because there are a lot of things happening, when you go into a crisis, right? That kind of diversification is really interesting. 

Just to take one step aside from this, something that I noticed in the news this week, and I know this is obviously near and dear to your hearts and for someone like Warren Buffett. I’m not an expert in Warren Buffett. But to me, he’s always sort of someone, who kind of argued for diversification. He invested in many different businesses, etc., etc. I noticed because of the success of Apple recently, that right now, he has like a 43% exposure in his portfolio to Apple. 

I think it’s just an interesting point, because you do need to find the sweet spot between diversification and conviction. I’m not saying that you can’t end up with, from time to time, a large exposure in a certain sector for sure. But also, for example, when I meet investors who come up to me and say, “Oh, great! I have an allocation to trend following portfolio.” And of course, I say, “That’s fantastic!” But then, you learn later on that it’s like 2% or 3%. And that kind of sinks your heart because you know that it’s not enough to make a meaningful impact on the portfolio as a whole, so it’s a lot of different things to take into account.

Preston Pysh 18:20
Niels, you had mentioned earlier that DUNN capital was founded back in 1974. What I find interesting is many younger generations are pulling data from the past and trying to develop whatever their model is. You’ve been doing it with real data, so what does your data show about trend following since 1974? And I’m very curious what your thoughts are about the last three or four years compared to the 1974-to-now time period, because I think what we’re seeing in the last couple years, just from a performance standpoint, it seems like that’s kind of a standout.

Niels Kaastrup-Larsen 18:58
You’re absolutely right. There are definitely benefits of having a 45-year track record. There are some drawbacks as well, because we tend to have had draw downs along the way, which people who just look at backtested performance never show. But the most important thing I find from having been around that long is that you have this real experience and experience from really some hard learned lessons that you can use in your research. 

One of the things you learn when you go through difficult times is, of course, back to one of your earlier points, the temptation of changing your model when you’re losing money is very high. However, it could be devastating if you did, so I think real experience is important. 

To answer your question, the type of trend following that we do have stood our clients very well, I would say. And actually, I would just want to add one thing, which I think is important from a context point of view: when we talk about our clients, we really look at them as partners in this journey, and we demonstrate that by never charging them a management fee for our services. We actually only make money, when we make money for our clients. And we think that’s the fairest way to treat investors. This is important, because it informs us in terms of how our research should be done. 

Niels Kaastrup-Larsen 20:18
Let me be a little bit vague here because of regulation. I’m not really allowed to say how well we’ve done, unfortunately. But of course, if your listeners would go to our website and accredit themselves, they can see all the data. However, what I can say, and I think this is relevant to answer your question, we have made three really big improvements or two major improvements over this period. In 2006 and 2013, we made big improvements.

What I often like to do, when we think about, “Have returns changed,” and because everybody remembers the 70s, the 80s, and the 90s, and think about certainly in our world as those being much, much better than in the last 10 years or so. When I look at those three different periods, so you have a 35-year period, a 14-year period, and a 7-year period, and if I look at our annualized returns, they’re almost identical. 

Niels Kaastrup-Larsen 21:12
This is important for two reasons. One is that, as mentioned, a lot of people have complained about performance in the last decade or so because of the central banks and how they have manipulated and tried to control the markets. Now, I would say that it has not been easy. And I will say, the last five years have not been great. But again, if we go back seven years, actually, our returns are pretty much the same as we’ve seen in the last 35 years. That’s one thing that’s important. 

But the other thing that’s from our point of view, which we focus on is, “Okay. If we’ve delivered the same level of return since 2013, have we done that through research with better drawdowns and with less volatility?” And the fact is, yes. The journey we started in trying to deliver this in a more appetizing way by making these improvements is really turning out to being delivered to the investors, not in terms of more performance, but actually in terms of same performance with less volatility, which is something that people generally tend to like.

Stig Brodersen 22:20
One thing that’s also interesting about the track record that you have Niels is that very few people on the contrary have been doing trend following, when interest rates have been going up. And we’re in this interesting point in the interest cycle today, but let’s not forget that they were going up until 1981. Then, actually, it’s been going down since. That’s a long-term trend. So, how is trend following different in different types of interest rate cycles?

Niels Kaastrup-Larsen 22:47
When you look at trend following returns, as you say, most firms haven’t been around that long. Generally, all of them have been trading through a period of falling interest rates, and there’s no doubt if you look at the attribution of return from the CTAs. In general, a lot of it in recent years have come from the fixed income sector, short-term interest rates and bonds. But as you rightly said, we have actually traded through a period of rising interest rate. I think it was 1976 to 1981, in particular, where we saw quite a long period of significant rise in interest rates. And when we look at our track record, we did really well during that period. 

Of course, that’s not a guarantee about any future returns on what they will look like. But what I will say is that, since we can be short as easily as we can be long in a market, my belief is that trend following is one of those strategies that can do well, when we do see a return to higher interest rates. This is actually also interesting in another way, because in the last 20 years or so, we’ve had this perfect correlation between stocks and bonds.

The 60/40 portfolio type approach has looked safe. But if you go back more than 50 years, you’ll actually find that more often than not, so I think it’s around 66% of the time, stocks and bonds are positively correlated. That means they go up and down together. When that starts to happen again, and we get into sort of more normalcy in terms of correlations, there’s going to be very little or no protection to be had inside the 60/40 portfolio. 

23:59
And then, you also asked about the various sectors and how they perform. Interestingly enough, for example, equity sectors, of course, when you have slow upward moves in the equity markets, as we have seen from time to time in the last 10 years for sure, equities is a great place to be from a trend following point of view. The challenge that we’ve seen in recent periods with the equity sector is that on several occasions now, it has gone into deep bear market territory, straight from an all-time high. And trend following, of course, you have to be long as long as the market goes up. 

That means that typically, we as trend followers will have the largest long exposure right before the market turns. We saw that in February of 2018. We’ve seen that in February of 2020. When you go through a crisis in equities, actually, as I said earlier, is not the place where we make a lot of money. We tend to make it in other places. This is why you have to be diversified, frankly. Not just in your own overall portfolio, but certainly also from a trend following point of view.

Preston Pysh 25:42
Niels, here at The Investor’s Podcast, I would say, the roots of our audience, and I know Stig and myself included, it’s all about Warren-Buffett’s-style value investing. For many of us not familiar with trend following, what are the first few and important steps to take us as we learn about this and to help us understand just the methodology and the approach?

Niels Kaastrup-Larsen 26:08
First of all, if you look at just any market, really, a value investor would be looking to buy a market that is moving down. The cheaper it gets, the more value you can get from it. That’s kind of the first main difference. We as trend followers would never be buying in a falling market. When it’s cheap enough, value investors would get into the market. As the market moves back up to say, fair value, you get a lot of the benefit of the trade. It will come in the initial phase. And of course, if the market moves up and becomes expensive, then this is probably a time where value investors would start thinking about getting out. So again, from my experience, you kind of live this buying low and selling high mentality.

I started out as a bond trader, so I’m fully familiar with the benefits of buying low and selling high. But then, I came across trend following, which is really the opposite where you buy high, because we’re waiting for this breakout to show up, the momentum to come in, and then hoping you can sell even higher. So, just comparing trend following to value [investing] and why I think they’re a good match is that trend followers won’t be buying at the low for sure. 

We’re going to be waiting. We’re going to be patient until the market starts to show some sign of an upward move. On the other hand, we don’t have this concept of something being too expensive. We’ll be “stupid enough” to stay in the trend for as long as possible, whereas maybe value investors have already left. 

27:39
I think maybe just speaking at this moment in time, Tesla is a great example of that because a lot of people didn’t expect Tesla to be able to go this high. Now, I will say, we don’t trade single stocks with Tesla. However, the concept is very important. What I found really interesting, and I think this ties into a lot of points in terms of our conversation today, also, as to why you may want to consider using rules rather than discretion in your approach, because I think it was *Barron’s, who this week came out with an article showing the “analysts’ price target” for Tesla. 

The highest was something like $2,300, and the lowest was $300. This just shows you how difficult it is to assess the price of anything. And of course, both of them are quite far away from where the actual price is. And I think consensus is like half of what the actual price is, so I think marrying discretionary type trading with systematic trading that gives you diversification on investment approach, and value and trend [investing], also, in my view, seem to be going well hand-in-hand, because it’s just another form of diversification.

Stig Brodersen 28:56
Whenever we’re looking at the market right now, and all the volatility we had this year, a lot of stock investors would say that it’s been quite painful to live through. And a lot of the strategies we have, they unfortunately tend to change during a crisis. Perhaps that’s whenever you really need to stick with your strategy, because we just can’t handle that volatility. I’m curious to hear if you could talk a bit more about how trend following strategies have performed in previous crises because you have actual data on that. Also, how the COVID-19 crisis is different, if it is different.

Niels Kaastrup-Larsen 29:29
In our case, we’ve been through, I would say, four crises that most people remember. We had Black Monday back in 1987. Then, we had the Tech Bubble in year 2000, the Great Financial Crisis (GFC) in 2008, and right now, 2020, we have COVID-19. And that probably is still unfolding.

These crises are very different. Black Monday was a relatively short crisis, only a few months. The Tech Bubble was the longest in time. The Great Financial Crisis was the deepest in terms of stock market losses. And then, COVID-19 so far, at least, has been the quickest, both going down and going back up again. 

All of these things present a lot of challenges for any investor and, of course, for trend followers as well. What I can say from our actual data, as you said, we’ve done well in all of these four crises. Perhaps that’s because we kind of blend a couple of different types of trend following techniques together. However, what I will say, which I think is maybe less talked about, is that in order to be successful through periods like this, you really have to overlay your strategy with a very strict set of risk management rules and framework. 

What decides whether you do poorly is not just based on the signals, where to go long and short. It’s very much dependent on how well you manage the risk, because keep in mind that no investor can control the return. 

31:16
We just don’t know what kind of return we’re going to get from our trades. However, what we can control is the risk we take and how we manage the risk. I would say, we spend a lot of time trying to become the best risk manager that we can [be]. And I’m sure the next crisis is going to be different from the previous one. 

Of course, I’m incredibly biased having done this for more than 30 years, but what I truly love about trend following is that it’s adaptive. We only look at price, and we don’t have any preconceived notion as to how those prices should evolve and how they should change. And so, this is probably why we have been able to handle many types of environments. 

Let’s be fair, we don’t do well in all environments. If you have short term sell offs that jump back straight away, I can think of February of 2018 as one of them. That was not a great time for a trend follower, but it’s only one month. And that’s what people have to recognize, the importance with any investment. I know you guys believe in that as well. It’s really having the patience to stay with the investment for a long period of time.

Preston Pysh 32:18
Niels, you were talking about risk management. And whenever I think about trend following, I think it’s so important to get something that when the trend changes that you have this sense of it continuing in the direction that you think it’s going to go. And so, when I’m thinking about how I would manage the risk of something being super volatile and reversing that trend, which I’m expecting to continue to go in a certain way, I would think that the market capitalization and the size of the particular pick that you’re buying would have a huge part of managing that risk. Would you agree with that?

Niels Kaastrup-Larsen 32:55
Yes. The way I would think about the question a little bit differently is maybe to say, if you were trend following, you only had one entry point and one exit point. This becomes incredibly important, but that’s not how we do it in real life. Essentially, we want to build up confidence in a market, so we do it across different timeframes. We do it across different levels of momentum indicators, in order to have this gradual move into a position. And as I said, sometimes it’s a gradual move out. Sometimes it’s a quick move out if markets really change. 

I do think this is what makes it challenging, certainly, for individual investors to try and do it themselves. I’m not actually a big proponent of kind of DIY trend following, simply for the reason that you need a fair amount of capital to get enough diversification across markets and timeframes, because otherwise, you end up becoming incredibly reliant on, as you say, one specific price, one specific correction, and therefore, the returns may look very different to what you expected. That’s another challenge for sure.

Stig Brodersen 34:02
I’m really trying to wrap my head around this combination of value investment and trend following, and it’s sort of like connecting to Preston’s question before: Where should we go from here? Because, I guess what I’m assuming the other investors are looking for is, “Whenever my normal value investing portfolio is not performing, then what will it perform?” And so, you were talking about February 2018 before, for instance. And you said, “Well, trend following didn’t do too well.” It wasn’t like value investing didn’t do well compared to the rest of the market, but everything just fell at the same time. So, how does trend following play into this?

Niels Kaastrup-Larsen 34:39
I think the answer is that investors are deep down looking for something that can make them money, when equities go down. So, you can come with all sorts of reasons why people would consider trend following, but I think it all comes down to that one point. You want to find something that can make you money, when the rest of your portfolio is going down. 

This is what became known about 10 years ago as Crisis Alpha. So when there’s a crisis then, can we produce some alpha? When I heard that concept initially, I was really excited, because I thought, “Wow, this is something that a lot of investors can hold on to, because it makes sense and it’s easy to understand.”

The challenge is that over the years, the definition of a crisis has changed. Before 2011, we thought about these crises, as I mentioned, the Dot-com Bubble and the Debt Crisis, or the Great Financial Crisis (GFC), and they were like a year and a half, two-year crisis periods. 

Then, come something like February of ’18, and it’s like one month. In fact, I think it was 12 days. The markets went down, and then they went straight up again. For us, that’s not a crisis. So, you have to look at these things in a much longer time horizon in order to see the benefit of combining these things like you have to really with all types of investments. 

35:59
Now, what I can say is that leading into February of ’18 from a trend following point of view, most trend followers had made a significant amount of money, especially in equities. So frankly, what happened in February of ’18 was we gave back about half the profits from the previous four months, which is okay. Over a five-month period, trend followers were still doing well. It’s just not to say that it’s a hedge. And I think, this is the danger. 

This is also why I think hedge funds have become a little bit of a sore point with many investors, because they use the word, hedge, in the name. We’re not a hedge. We’re an uncorrelated return stream. There’s a huge difference between being a negatively correlated higher hedge, or a non-correlated [hedge] as we talked about earlier. Sometimes we will be highly correlated to equities. Because if equities go up, we’ll be long for sure, and so on and so forth. 

Niels Kaastrup-Larsen 36:53
You’re right, and I do think that the next 5 or 10 years, given what’s happening in the world right now, I know from listening to many of your podcast episodes that there is a lot of concern out there in terms of what the world could look like, and we are in a slightly different place from where we’ve been before. And so, I truly believe that the next 5 or 10 years, what will make or break your portfolio is whether you get the strategic asset allocation right. 

And so, back to Ray Dalio and his holy grail. I think that is the only thing we as investors can do, and that is to try and find things that are truly uncorrelated, not on a daily basis, not on a monthly basis, maybe not even on a yearly basis, but in the long run. And then, build something whereby you don’t have to sit and worry about your portfolio every single day or every single month.

Stig Brodersen 37:41
We had a call here not too long ago, and we were talking back and forth about this interview here today, what we wanted to talk about, and one comment you had was, “To be successful in trend following, you just have to fight against all your basic human instincts.” I sort of like that statement. Could you please elaborate on that, especially for those who have been doing trend following and have tried to go through the pain of fighting against everything that you think is true and right?

Niels Kaastrup-Larsen 38:09
From an overall point of view, you could argue that nature could not have designed a worst investor than you and I, right? So in every single way, we’ve evolved. We’ve evolved for immediacy and instant gratification. We’ve evolved for certainty. We’ve evolved for taking action, but success in investing really takes dealing with uncertainty. It takes restraint. It takes patience, and it takes not listening to your own gut. 

When you combine our kind of human design with CNBC and Bloomberg, where you constantly have this breaking news and trade recommendations, which of course deep down only qualified guesses about an unknown future, it really sets a lot of investors up for disappointment, when it comes to making the right decision. 

And I think In fact, there was a study or something that was published by Fidelity, where they had done a review across all that client accounts and found that those who had done the best over the long run were typically people who had either forgotten that they had an account in the first place, or they had passed away i.e. people who did not do a lot of trading. 

This is actually quite topical for our discussion right now, because we have this huge resurgence in day trading with the Robinhooders. Unfortunately, I think that when the next bear market comes, a lot of these investors will be completely wiped out. 

One, there’s a clear correlation between activity and investment performance. Those who do the worst tend to be the ones, who ironically keep the closest eye on the markets. And I think it was Jim O’Shaughnessy, who wrote in the book, What Works on Wall Street: “The first thing you have to do as a behavioral investor is to recognize that you are just as susceptible to the same dumb mistakes and crippling behavior as the next person.” We need to be aware of that. 

Niels Kaastrup-Larsen 40:08
But of course, there are certain biases that I think I was referring to when we spoke initially, and those are things like ego. We have this tendency to be overconfident, essentially. We see this in many different ways in life. If you ask someone if they consider themselves a good driver, I think you’ll find that a huge percentage will say, “Yes, I’m a great driver.”

I even heard about a study where they asked, I think around 700 men, if they thought of themselves as good-looking. And again, you have this huge percentage of [men] saying yes, almost to the point where you feel that like, they’re only five sit ups away from dating a supermodel. And so, overconfidence is a big problem for us as investors. 

The other thing is that we’re very conservative as people. We like the status quo. We don’t really like change, which is very hard to deal with when it comes to investing, because it changes all the time. And of course, the other thing, which I think Kahneman came out with, we have this different perception of gains versus losses. Losses feel much harder on us as investors, which leads us to take the wrong decision at the wrong time. 

Then, another bias I can think of is, we have this I think it’s called, attention bias, where we think of the possibility of really a dramatically bad outcome, much more than the probability of it actually happening. The fear we have can often play with our decisions when it comes to investments. And then, of course, we have emotions. 

Generally speaking, it really does cause investors to overall under react to information, I would say. So, this is really why trend following in essence is different, because we want to take out all of these emotions and biases from the investment strategy and just follow rules and not try to predict anything. Interestingly enough, at the end of the day, it comes back to human behavior. 

If you take an example from the equity world, just to take a step away from trend following, one person that has really worked out human behavior very well is Amazon’s Jeff Bezos. Because what he’s basically built his business on is specific behaviors that he felt would never change, namely that we would always want things as cheaply as possible and as quickly as possible. These are very basic behaviors and look at what he’s done. I mean, [he’s] the richest man in the world.

Preston Pysh 42:39
Niels, where can the audience learn more about you, your two podcasts, and DUNN capital?

Niels Kaastrup-Larsen 42:46
Thanks for asking. I think the best place to learn about DUNN and the journey we’ve been on is really on our website, where there’s also a lot of educational resources. So, for that, you can go to dunncapital.com, and you have to register to get access to all of the information, but that’s purely for regulatory purposes. And of course, if people want to follow kind of our ongoing journey, then the podcast is toptradersunplugged.com.

Stig Brodersen 43:10
Before we let you go, I have one question that I think I’m probably not the only person here in the audience, who is thinking about this: Do you have a go-to resource? Is there any kind of best-selling book [in trend following]? In value investing, we would have The Intelligent Investor. That’s the Bible. Do you have something similar about trend following that is a-must resource? We are very big on book recommendations here on the podcast.

Niels Kaastrup-Larsen 43:36
There are a few different resources on trend following, of course. And it all boils down to usually books or white papers. The CME Group is the largest futures exchange [group]. On their website, there is in particular, one short, white paper, I would call it. It’s called, Dr. Lintner Revisited. I think that’s a great introduction, because it actually looks at some research that was done back in 1983. And then revisit, whether it still holds. So, that’s a good way of getting into that. 

But if you don’t mind me being a little bit selfish here, because I actually created this guide where I put in like 100 different books that I think all investors should be at least contemplating diving into. And in that guide, there are actually quite a few books mentioned specifically on trend following, and from what we’ve done, I think the link is toptradersunplugged.com/tip. When you go there, you actually also get a book that I co-wrote, specifically on trend following. I would say that’s the best place to go.

Stig Brodersen 44:40
Fantastic! The website Niel’s mentioned is toptradersunplugged.com/tip. That’s toptradersunplugged.com/tip, for Niels’ book guide and his free book. We’ll make sure to link to that and the other thing that we will be linking to is your new episode with Preston, Niels, where you’re talking about the failure of the US dollar. So, we’ll make sure to link to that in the show notes together with all the resources that you just mentioned. Niels, thank you so much for being so generous with your time and teaching us about investing and trend following.

Niels Kaastrup-Larsen 45:18
Thanks so much, guys! It was fun, and thanks for having me.

Stig Brodersen 45:22
All right, guys. That was all that Preston and I have for this week’s episode of The Investor’s Podcast. We’ll be back again with another episode next week.

Outro 45:31
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