Replicating Hedge Funds Using Machine Learning feat. Bob Elliott | Aspen Funds
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Replicating Hedge Funds Using Machine Learning feat. Bob Elliott

 

We discuss the use of machine learning to create products that replicate the index returns of alternative investments. We talk about the impact on hedge funds, venture capital, and private equity. Bob Elliott is the Co-founder and CIO of Unlimited Funds, a company dedicated to creating an Indexing revolution in the Alternative Investments space.

 

Connect with Ben Fraser on LinkedIn https://www.linkedin.com/in/benwfraser/
Connect with Bob Elliott on LinkedIn https://www.linkedin.com/in/ttoillebob/

 

Invest Like a Billionaire podcast is sponsored by Aspen Funds which focuses on macro-driven alternative investments for accredited investors. https://aspenfunds.us/

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Transcription

Unlocking Unique Investment Perspectives

Bob Elliott: If you just take all the people who have taken the same classes and learned the same canonical set of thinking, they’ll all basically have the same view of what’s likely to transpire. As you look at some of the biggest hedge funds in the world these days, they really are looking for a wide variety of different perspectives.

Which can bring that unique perspective and see things that other people couldn’t see. 

Ben Fraser: Totally makes sense And if you’re thinking like everybody else, you’re just investing in the market. You’re going to get market returns. It sounds so simple. But to get a better return you have to think differently to find the opportunities other people aren’t seeing and sometimes it requires a different Perspective from another area that you can translate into this area, right? 

Bob Elliott: Money hasn’t tightened enough Just slow the economy.

The expansion continues, but we’re starting to get to the difficult point of that expansion where we’re going to have to tighten money more. Either the Fed will have to do more or. 

Introducing Bob Elliott and Unlimited Funds

Ben Fraser: Hello, Future Billionaires! Welcome back to the Invest Like a Billionaire podcast. We’ve got a fun episode today talking with Bob Elliott of Unlimited Funds.

The Power of Diverse Thinking in Investing

Ben Fraser: So Bob is a quant. He’s a macro guy. He comes from the world of hedge funds. 

Exploring Alternative Investments with Unlimited Funds

Ben Fraser: And actually spent the majority of his career at Bridgewater, which is now the largest hedge fund and really has brought a really cool perspective to the alternative investment space where most of the hedge funds and a lot of different types of alternatives, as you may know, have difficulty being accessed for a lot of investors and they also lack liquidity many times.

So they are using machine learning and different models that they’ve been running for a long period of time to replicate the returns in the portfolios. Of hedge funds to be able to bring the alternative investment benefits using liquid public market securities. So you have the ability to still have liquidity.

So really cool. We get all into the weeds of it here, of how it works, how they use this model to work. with hedge funds, work with VC firms, also work with more traditional private equity. As you’re all Thomas, we’ve talked about how they’re replicating that in their models, trading publicly traded securities.

And then at the very end, we talked a lot about macro and where he sees the market going. Very smart guy. I think you’re really going to enjoy his perspectives here. Definitely aligned in a lot of ways. And I do want to give the caveat as I always do on any episode where I bring on someone who may be raising capital.

This is a disclaimer that you have to do your own due diligence, do your own research. We don’t perform due diligence. We bring people on to the show. We bring people on because we’re curious about things that they’re doing because of expertise, but have not done any due diligence on the track record, what they’re offering.

So if there is interest that’s on you to go perform that due diligence or talk with advisors, talk with people that know these. So with that, enjoy the show. 

This is the Invest Like a Billionaire podcast where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you’ll learn from this podcast will make you a better investor and help you build legacy wealth. Join us as we dive into the world of alternative investments, uncover strategies of the ultra wealthy, discuss economics, and interview successful investors.

Welcome back to the Invest Like a Billionaire podcast. I’m your host, Ben Fraser. Today, we’ve got an exciting guest to chat with. 

The Journey from Bridgewater to Unlimited Funds

Ben Fraser: With Bob Elliott, he is the co-founder, CEO and CIO of Unlimited Funds. He uses machine learning to create low cost index replications of two and 20 alternative investments like hedge funds, venture capital, private equity.

So that’s a mouthful for those of us that aren’t as smart as you, Bob, give us a little bit of your background and what that means and what you’re doing right now. It’s really interesting. 

Bob Elliott: Yeah. Thanks so much for having me. I’ve spent a couple decades as a systematic investor. In the two and 20 spaces.

And when I say two and 20 what that often refers to is basically the sort of strategies that charge a 2 percent fixed fee and a 20 percent performance fee. So things like hedge funds, venture capital, private equity, et cetera. And during my time in the two and 20 world, I increasingly realized that many of those strategies, they’re particularly good for the managers.

And not that great for the investors. And the reason why that is, is they’re often structured in a way where the fees are too high for the investor, where liquidity is difficult for the investor to gain access to, and where for a, particularly for taxable investors they’re put in structures that are not necessarily the most tax efficient.

Vehicle for the everyday investor. And our idea around Unlimited was to use technology and our decades of experience to basically replicate how those managers are positioned in close to real time, and then package that into assets, into financial assets, things like ETFs and other structures.

Which makes those returns available to a broad set of investors in a way that’s much more liquid, transparent, and tax efficient than what’s out there today. 

Ben Fraser: Love it. Okay. Super excited to get in. Before we get into the model and how you’ve created this, give a little sense of your background because obviously you got some big names on your resume, including Harvard, Bridgewater.

Talk a little bit about just your journey in this space. And really what brought you to this point now, where did you see an opportunity and, why did you start Unlimited? 

Bob Elliott: Yeah my background academically is probably pretty unusual relative to most of the people you talk to.

I was a botanist by training academically, though maybe that’s what I would do with my career. And the pure sciences, I think we’re a pretty unique way of thinking that was, that’s always been useful and in, in applying it to the world of markets and macro economics and investing.

Because in many ways, if you think about the macroeconomy, it’s just one large complex system that’s where lots of different pieces are interacting with each other all at the same time and to understand the macro outcome, one case growing a plant and the other the macro economy, you have to understand all those underlying systems and how they interact with each other.

And so that is a particularly, I think, unique lens into the world. And when you think about investing in general you have to have. A unique perspective, a non consensus perspective in order to generate differentiated returns over time. And then I, started after I left college, started to get interested in macroeconomics for a variety of reasons and spent almost 15 years at Bridgewater Associates, which transitioned while I was there from being a small challenge organization in the woods of Connecticut to being the world’s largest hedge fund.

I didn’t predict, particularly focused on systematic macro understanding. 

Ben Fraser: That. That’s so cool. I’m a little bit of a fan of Bridgewater and Dalio. And so those who are listening, don’t know those names. You need to go do some research, Ray Dalio. Started Bridgewater, some partners and it’s so cool because you hear you say your background in botany might be unique, but Ray was famous for this where he skewed the normal models of you got to go to Ivy League at the NBA and a finance degree and, and go through the system and then come over here.

He wanted people that thought differently. And could bring disciplines from other areas and apply them into investing because as you said, investing mimics a lot of different areas of life or science of the world and understanding these things in the components of it. You don’t have to just learn in an accounting, 201 class. 

Bob Elliott: Right? I think if you think about how you generate alpha in markets and alpha meaning, how do you generate returns that are differentiated from, passively investing you have to, the way you do that is by having a unique perspective. a non consensus perspective on what’s going to happen, to the economy, to markets, to various investment assets, depending on what you’re looking at.

And if you just take all the people who have taken the same classes and learn the same canonical set of thinking, they’ll all basically have the same view of what’s likely to transpire. In the world. And so part of the edge that Bridgewater certainly focused on this early, but as you look at some of the biggest hedge funds in the world these days, they really are looking for a wide variety of different perspectives , backgrounds, academic experiences, et cetera.

Which can bring that unique perspective and see things that other people couldn’t see. 

Ben Fraser: Yeah, no, totally makes sense. And you alluded to it, but the idea of alpha or generating above market returns, which If you’re thinking like everybody else, you’re just investing in the market, you’re going to get market returns, right?

So it’s, it sounds so simple, but to get a better return, you have to think differently to find the opportunities other people aren’t seeing. And sometimes it requires a different perspective from another area that you could translate into this area. And so I, one, it’s just, I love that I nerd out on, on, on the background there, because I think it’s such a cool experience.

Talk a little bit about, so working for the world’s largest hedge fund, from our research, our perspective, and this whole kind of goal to show educating around alternative investments there’s some sort of distinct advantages, right? Where you see a lot of the ultra wealthy investors, the endowments, the pensions, the family offices, institutional investors are investing in these types of assets and have been for a long time.

And, with great success and sometimes not, but having a more diversified portfolio, having alternatives as part of the portfolio, that’s become a Standard in a lot of ways, right? Where maybe 30, 40 years ago, it wasn’t, but there are some downsides, right? The, probably the biggest one being liquidity.

And so talk a little bit about your time spent at Bridgewater. What did you see that worked well? What did you see that was, how’d you guys grow into the biggest hedge fund, right? Number one. And then number two. What led you to leave and do your own thing where you maybe saw an opportunity that wasn’t being addressed?

Replicating Hedge Fund Strategies for Wider Access

Bob Elliott: Yeah, I mean I think for The world of institutional investing if you just look at it You know most institutional investors these days put about half of their capital into alternatives and there’s a lot of good reasons Why they do that combination of higher risk adjusted returns, greater diversification and really access to outcomes that wouldn’t otherwise be available.

To just purely in the public markets. And so I think when you think about that space, the real advantage that hedge funds bring is the ability. To tactically move, long and short between assets. That’s something that a lot of different strategies, whether you’re passively invested in stocks or bonds or.

More structurally long alternative assets like private equity and venture capital, you don’t have that opportunity to navigate and switch your positioning depending on the market. Now, in general, being long assets and being invested is the right strategy to do in general over time. So it’s not to say you want to.

Put all your money into a long and short strategy, but there are certain times when those strategies can be complementary to an overall portfolio being long assets, and that’s really what hedge funds bring to the table is that ability to bring using long and short positions in liquid markets to be able to That that agility to your portfolio that you otherwise wouldn’t be able to do.

And frankly, part of the reason why they’re so successful is they’re able to hire some of the smartest minds in the world to be able to generate that alpha, to generate those strategies. And you’re essentially hired to do that by institutional investors. And the outcome is, as you say, which is the institutional investors in part, because of their allocations to things like hedge funds.

Typically experience meaningfully better risk adjusted returns than the everyday investor. 

Ben Fraser: Yeah. Talk a little bit about just how hedge funds work. We’ve talked about this in previous episodes, but it hasn’t been the primary focus for us just because it does seem, set aside for the big investors and not as accessible to more everyday retail, credit type investors.

But talk about the idea of long and short, right? Because if you’re investing in real estate. You’re buying an asset. You are narrowly in a long position, meaning you’re bullish on the future value of that being higher than it is now. For whatever reason, but in hedge funds, you’re generally trading in public markets, liquid markets.

And you can create hedges with different positions, long versus short betting on, different things going on. Talk about where that kind of fits in a portfolio from your perspective in explaining what that means a little bit more.

Bob Elliott: Taking, are trading some of the largest liquid markets in the world. Things that you see covered regularly on CNBC stocks, bonds, currencies, commodities, fixed income credit, et cetera. Maybe a hundred or 200 of the world’s largest liquid markets. And one of the nice things about typical hedge fund structures is that they have the flexibility to go long and short.

They’re. In general, as an example, you want to be long stocks because stocks, there’s good reason to believe that stocks will go up over time. Say relative to holding your money in the bank in cash, but there are certain macroeconomic circumstances where stocks go down. And I think one of the challenges for many long only investors and really the challenges for any passive investor is that if you’re just simply.

Staying long through time, you can experience meaningful drawdowns. For instance, in stocks, you can experience 60, 70 percent drawdowns. In your equity market portfolio. And so what hedge funds are really focused on doing in general is trying to identify those circumstances where, you know, one or many of the, those major asset classes have pressures on them to either go up or down more substantially than what’s expected in the market, and then build a portfolio of trades, which are really just bets on those markets.

And so one of the benefits of being in a hedge fund structure is that flexibility Going long, going short, not being locked into a particular view and being able to respond to what is likely to occur in the macro economy. 

Ben Fraser: So if values go down, if you have short positions and you actually make money versus losing money.

And so you have that flexibility to be. Go back and forth and be agile, as you said. So what was really the driver for you to leave Bridgewater? I’m sure it’s got its pros and cons, but obviously sure. Great experience in what will lead you to start Unlimited. 

Bob Elliott: Yeah. It’s definitely a great place to start my career and also, help be, help build something that went from that sort of challenger world, which is hard to believe given where it ended up, but that’s, it was that way when I started to be the incumbent.

I think, naturally companies as they move through that life cycle to incumbency start to slow down the desire to innovate starts to moderate as well. And the frank reality is I’ve always enjoyed smaller, leaner, startup type environments. And so I want to get back to something that was the new challenger on the market.

And co-founder Bruce McDevitt and I saw that there really wasn’t anyone in the market trying to bring two and 20 style strategies to make them more accessible, but also cheaper. There’s a lot of work to try and increase accessibility, to increase accessibility, but in certain circumstances, those strategies may end up adding to the fee problem or adding to the illiquidity problem.

Rather than reducing fees, increasing accessibility and increasing liquidity. And so we saw an opportunity to build technology based upon our 50 years of experience between the two of us to be able to build replications of those strategies. And because we’re building replications using liquid public market securities, we could package those things into liquid securities like ETF structures or other structures.

And because we’re using technology, we could do it at a much lower fee point. And so our basic idea, basically the premise behind unlimited is that idea of diversified, low cost indexing in the same way that has changed and totally revolutionized stock and bond investing, bringing that to the world of two inch one.

Ben Fraser: Yeah, makes sense. So talk a little bit about just practically how you do that. Because what you’re saying is. Hey, there’s obviously some clear advantages of these alternative investments. Otherwise, the big money, the smart money wouldn’t be doing that. But the limitations are usually accessibility. A lot of the models that have created accessibility either might be feeder funds and have other layers of fees, or they’re just limited to accredited or qualified investors that have to meet certain minimum financial thresholds to even have access to them.

Some funds, I know, you can’t even access without an advisor and, certain levels of advisory. And what you’re saying is, Hey, what if we can replicate the benefits of some of these models, the 2 and 20, but actually make it lower cost and use liquid investments to also reduce the illiquidity downside of this.

Am I hearing that right? 

Bob Elliott: Yes. That’s exactly right. And the way that the key to being able to do that is through our return replication technology and it’s. What we do is we can look at manager returns and compare those returns, which we see in close to real time.

And we compare those returns to what’s happening in financial markets. And basically back out, infer how managers must have been positioned to generate the types of returns that we’re seeing. It’s the sort of thing you must do, everyone does when they’re looking at a particular manager’s returns, right?

Say, a manager, you see how they did in let’s say a given month or a given period, what happened in the markets and you say look I know they must’ve been overweight tech or, underweight bonds or overweight stocks to get the kind of outcomes that they’re doing.

All we’re doing is just taking that core concept and just applying it. Using machine learning, which is really just a more computationally rigorous way of approaching that problem then, then just eyeballing it and guessing it. 

Ben Fraser: Interesting. So are you using correlation analysis?

At this time period, they were up this percent and, the Tech was up similar in, or if you back out that, then, where’s the alpha coming from? Or what’s the process statistically that you’re replicating the returns of these broad managers?

Bob Elliott: Yeah. There’s been a, almost 30 year story around hedge fund replication. And a lot of the original work was built on that exact intuition, which is you could basically use regressions of returns. Of managers against asset returns and back out how they must have been positioned over the course of a multi year period.

I think one of the things that’s really exciting is that there’s been a real advance in our ability to use certain computational techniques to be able to, instead of having to use that long look back window, really get a much more tangible sense of how managers are positioned. It is close to today that we see when we see their returns and the way that we do that, it really stems from a basic insight, which is that because positioning is continuous, there’s path dependency and positioning.

So the outcomes that you’re seeing today in terms of returns are a function of today’s positions. And today’s positions are a function of yesterday’s positions, which you can observe. Through yesterday’s returns, and so functionally, what we do is we essentially run a large Monte Carlo simulation to create probabilistic portfolios that best describe the returns that we’re seeing, and those are constrained by the portfolios that must have described the full series of returns, not which are adjacent to each other, not just a single point in time or a long look back window, and this is a sort of techniques, particularly in machine learning or statistical learning, depending on how you think about it.

That really weren’t commercially viable even five or 10, five or 10 years ago, and it’s actually approaches that we’re using today, going back to the previous commerce, previous part of the conversation that are drawn from things like weather forecasting techniques drawn from other areas of forecasting that we’re bringing to the table to use in this context.

Ben Fraser: Yeah, so interesting. So you’re saying it wasn’t cost effective or the barriers were too high a decade ago. Is that due to The speed at which computers could make these calculations. We’ve progressed enough to where you can run more simulations faster and get more insights quicker. Is that the breakthrough that’s happened in the past 10 years? Or what’s the difference between now and 10 years ago? 

Bob Elliott: Yeah. There’s always this interesting, as a systematic investor for several decades I’ve used a wide variety of different tools. And approaches and there’s always this interesting interplay in terms of technological advancement between essentially commercially viable computational horsepower and technique availability, right?

And those things play into each other because the more computational horsepower is available, the more emergent techniques exist. And the more that those emergent techniques exist, the more that they require the computational horsepower in order to be effective at them. And there’s been this is a constantly evolving world in terms of the techniques that are available.

What was running regressions 30 years ago on, 3000 managers returns was pretty sophisticated. And it was the basis. Of the sort of underlying fundamental ideas of replication, manager replication. But today we can, today we can run 5 million simulations, in, in a very short period of time.

And that, 5 million simulations for every month for the last 30 years. We could run in a matter of minutes and hours rather than essentially an impossible task 10 or 15 years ago. 

Ben Fraser: Very interesting. Okay. So let me throw a few kinds of harder questions at you because from my perspective I’ll have the numbers in front of me, but in looking at the most successful VC firms, the most successful hedge funds, generally from the numbers I’ve seen, maybe you’ve seen other numbers.

It’s a very small subset that has the most outperformance. So the average returns may not be that much better than the market, but the top, 1%, the top decile. This, the amount of outperformance in that relative to the rest of the group is so significant that it makes you wonder what they are doing differently than others, right?

And you apply that to maybe VC where they’re trying to select what’s going to be the next unicorn business. And consistent success with certain groups versus others, right? So how do you take that into play? Because there might be an element of, okay, if you have enough, if you’re big enough sample size of data.

You can get a sense of what the portfolio is, but is the alpha being driven by portfolio selection or is it being driven by. Some unique aspect of a philosophy, a niche, a looking for some, unquantifiable X factor in the founder, right? How do these things play into that model?

And there might be limited understanding. That I’m bringing to this question, but help me work through that. 

Bob Elliott: Yeah I think it’s probably worth first starting in the hedge fund space. And I think it’s a very interesting space because the aggregate of the hedge fund industry generates a fair amount of alpha, meaning they generate better than market returns relative to the risk that they’re taking.

Particularly if you. Take away those extraordinarily high feet, right? So that’s an important component, right? So the aggregate industry without the fees is quite good on its own, hedge fund returns gross of fees over the last 20, 25 years have been a bit better than stocks with about half the monthly volatility, about a third of the drawdown.

So definitely a, quite a compelling return. When you go under the hood and look at individual manager performance. One of the important insights that we’ve discovered is that there is no single manager outperformance persistence. So the odds of any one manager. Will be say in the top 50 percent of performance for consecutive periods is about equivalent to random.

Of course, there has to be some manager, right? If you randomly select managers, of course, some managers will do better and some managers will do worse. And there’ll be some persistence in that because, naturally due to sheer randomness, some will be better and some will be worse. But that’s a function of luck, not a function of skill.

And so if there is no strategy, outperformance, persistence, or single manager, outperformance, persistence, you’re much better off building a diversified portfolio of their views and lowering the costs. Then you are trying to select a manager that you think is top decile, maybe top decile for one year. But not necessarily, but essentially impossible to identify the top decile for an extended period of time.

Ben Fraser: Very interesting. So what you’re saying is the persistence of being in that top decile is pretty rare, if not random. And if that’s the case, then it does have more to do with luck and hey, we just had the best positioning in the market given all the circumstances going on. That happened to work out, right?

But maybe next quarter, next year it’s the opposite. How do you apply that to maybe VC? 

Venture Capital and Private Equity Replication Insights

Ben Fraser: Is that a different approach in your mind? 

Bob Elliott: There has been some academic literature which suggests that on a pro forma basis, not on an ex post basis, but on a pro forma basis, it’s actually pretty hard to identify Which funds are likely to be persistent outperformers.

But even if you acknowledge that there are structural reasons why certain funds might have advantages over time, because they get that access to better deal flow, et cetera. You still have to answer the question around fees and taxes and illiquidity. So as a simple example, actually venture replication is a lot easier than hedge fund replication because venture in general is long only and the fees are very high.

A typical, two and 20 or, Maybe it’s two and a half or three and 20 venture fund might charge on average between five and 8 percent in annualized fees a year. If you can, if you could offer a product that has under 1 percent fees that’s a lot of what we call fee alpha that exists there.

And when you take into consideration the fee alpha that’s available To, through the process of replication, you actually can compete beyond par with, or better than, those funds that are persistently in the top deciles of performance. 

Ben Fraser: Okay. Interesting. So going back to the venture side of things, from, things that I’ve learned in school and things that I’ve been taught is, part of the value of VC is one identifying design.

Yeah. The right founders, business ideas, markets, et cetera. But when they IPO we see this huge, usually Delta in, now liquidity premium and kind of the private market discount, of having liquidity in a lot of times. You get obviously these big pops in value once you can be publicly traded.

And so there’s an element of, Hey, if you can get to that point to then go IPO or be sold to a publicly traded firm that creates an additional alpha. Is that something that you can replicate a model? Or I was trying to understand how you replicate VC and the model? Or is it mostly just hedge funds?

Bob Elliott: Yeah. When you’re thinking about venture. Something like 85 percent of the returns of the overall venture investing industry are concentrated in just a couple of dozen of a private company. So it’s very small, and that’s because those companies are so large, right? Can you replicate million dollar checks, seed checks to random companies?

Of course you can’t, right? Using public markets. But when you start to become a company that’s as big as, say a SpaceX, that the question is when or an Instacart, as a simple example, when you’re that big, the, you are knocking on the door of IPO ing, and so investors in those businesses are Start to think about those businesses in the context of publicly traded competitive companies.

So if you’re an Instacart, what is Instacart? It’s basically just like a stripped down version of Uber Eats or DoorDash, right? And those are publicly traded companies. And so you can go ahead and there’s an arbitrage, a natural arbitrage between those two cohorts, between the privately listed, the privately privately owned company in the venture space and the valuation of the publicly traded comparables.

And so in order, since there’s all, there’s not thousands of these companies that drive the returns. There’s dozens of these companies. You can start to think about what the portfolio of publicly traded companies effectively relates to the valuation undulations that will likely occur with those private companies through time.

As they move through that transition of being a growth stage venture company, To then being a company that is publicly traded in the IPO market. And that’s basically what drives that the dollar value of venture returns, rather than the sort of percent changes, which mostly comes from random 1 million checks into seed view.

Ben Fraser: Okay. What about for more traditional private equity, right? Where, firms going and buying businesses, doing leveraged buyouts, maybe doing a roll up strategy. So they’re trying to aggregate certain types of businesses in an industry to create multiple expansion because of size and sophistication.

Is that something you can replicate in the model or not really? 

Bob Elliott: Yeah. When you think about private equity and particularly when you start to think about something like buyout private equity what are they doing? They’re basically buying high free cash flow businesses that are cheaply valued and leveraging.

And then they may or may not be adding value beyond what the public markets can, efficiencies and things like that. And so if you just think about that case there are publicly traded comparables that are either direct targets for bio private equity, right? In the sense that they are targets of actually being bought by those funds, or they’re essentially very similar in attributes to the types of companies that those funds are purchasing in the private market.

And so as a simple example, if you were to simply take the Russell two K value index, and you were a lever at 1. 75 You would have a top decile private equity fund return that is, 90 percent correlated to the accounting matched returns of the buyout private equity index over the last 25 years.

Now, what we’re doing is a little more sophisticated than that because there’s changes in sectors which are non trivial in terms of what drives those returns, like the shift from more industrial, traditional industries 20 years ago to more tech and healthcare today. Are an influence in terms of the overall returns, but the core basic idea of go buy Cash flowing businesses and lever them and that is what generates your returns like that can definitely be Put together in the private market.

Ben Fraser: Wow, very cool. 

The Structure and Benefits of Unlimited Funds

Ben Fraser: So talk a little bit about how you’re structured is your Fund is it also? Private fund. If it is traded it talks a little bit about how you guys run your fund. 

Bob Elliott: Yeah. So we have created our first products around the hedge fund replication approach. And we use that technology basically as the foundation of products that we build both for.

What I’d call an advisor directed retail investors. So advisors who are looking for alternatives in their portfolios for their clients who may not have clients that are qualified purchasers or accredited investors. And are looking for an alternative typically through, through a 40 act product an ETF product, which is for most investors, for a small scale investors, ETFs are the most efficient way in which they can gain access to, to various strategies because they’re tax efficient, low cost, and very liquid.

And we also have used that technology to create a product more targeted for institutional investors. They can switch between different hedge fund style strategies at a time when, the macroeconomic conditions align with certain strategies, say, global macro or fixed income strategies or equity longshore strategies, shift between strategies when those underlying hedge fund strategies are likely to do better or shift away from them when they’re likely to do worse based upon macroeconomic conditions.

Ben Fraser: Got it. Okay. And then how is your fee structure different from maybe a traditional hedge fund? 

Bob Elliott: Yeah, so when you’re thinking about it from the perspective of an ETF , those fees are typically fixed fees, fixed management fees That are typically associated with an ETF and the vast majority of ETFs are priced under 1 percent in terms of the annual fee.

And so that’s considerably lower than you might see with a typical 2 and 20 structure, which is, maybe something like 400 basis points a year or 4 percent a year. And then other, the other thing important to recognize for taxable investors, ETFs. Are are also more tax efficient because if you typically if you buy an ETF and hold it for more than a year, it gets taxed just like a stock from the perspective of being charged capital gains at the point of sale, which is very different from traditional LP investments, which typically generate a K one income that you have to take annually, regardless of whether or not you sell out of the position and you’re taxed on those gains that have to pay the taxes on an annual basis.

Ben Fraser: Yeah. Okay. Very interesting. So you sound, it sounds like you said advisor related retail or advisor sourced retail investors. So investors need to go through their advisors to access the funds, I’m assuming, or do you guys have direct to retail or to consumer access? 

Bob Elliott: Most, Most retail platforms that folks are trading on our product are accessible there.

But the reality is that This is a sort of product that’s not going to become the next meme stock. It’s the sort of thing that regular advisors who are trying to build robust institutional quality portfolios, but instead of using direct investments into managers, what they’re using are, ETF model portfolios.

This is the. The sort of product or strategy that fits into that alts bucket of your ETF model portfolio and where you might have an equity allocation or a bond out. 

Ben Fraser: Got it. Make sense. Okay. 

Navigating the Current Economic Landscape

Ben Fraser: I’d be remiss if I didn’t ask you, cause I know we nerded out about this before we on our last call, but talk a little bit about macro.

Just what are you seeing in the kind of bigger picture? Obviously you’re intaking a lot of data. You’re looking at a lot of regressions, correlations, things that are working, things that aren’t working. That’s all historical. Data, right? How are you positioning for the future? What are you thinking about?

What are the big kind of knobs in your head that are impacting the investment themes and thesis that you’re using right now? 

Bob Elliott: Yeah. I think in many ways we’re experiencing an economic cycle or an economic period that is very traditional in the sense of an income-led economic expansion.

Which is creating inflationary pressures, which are being responded to by the central bank and the Fed in this case which tightens monetary policy and response in order to slow the economy and bring inflation down. That cycle is actually a bit unusual for most people because most people in their professional careers have basically lived through the 2000 cycle, which was like an asset bubble and bust, the housing crisis, the housing cycle of a weight, which was an asset bubble fueled by debt.

And then bust or COVID, which was just a totally unusual circumstance, that hadn’t happened in a hundred years. And in all those cycles, there was basically, a rapid buildup of unsustainable activity and then an immediate quick sharp reversal. And then, and it was very abrupt, in part because there was so much debt in the system or money creation in the system that was driving the economic activity.

So when that stopped, then the economic activity stopped. What’s happening right now is totally different from that, which is that, as I like to describe, we have an income-led expansion. So people are earning, increasing salaries 5 or 6 percent a year. They’re taking that and they’re spending it, and that spending is becoming someone else’s income, and that’s a positive virtuous cycle that’s super sustainable.

And the reason why it’s sustainable is because if I spend money and it becomes somebody else’s income, and then they spend money and become somebody else’s income, then There’s no way the way debt creation debt is something you have to pay back income. You don’t have to pay income back. So if you spend out of your income, you don’t have to pay it back.

And so that’s created a durability of this recovery of this expansion that has surprised most people because most people expected to see, as interest rates rose the economy faltered, but that only occurs when you’re borrowing a lot of money and that’s not what’s going on in the economy. And so the result is that.

The economic expansion has been longer and stronger than what most people had expected, including the Fed, and it means that those inflationary pressures have remained more persistent than certainly desirable by the Fed, which is essentially creating several rounds here of recognition that’s what’s going on.

We’re in one of the latest rounds. Where the expectations of the Fed policy for 2024 have moved from cutting, at the start of the year, they were expected to cut between six and seven times over the course of the year. And that’s basically close to zero times right now, but we haven’t quite had enough.

Of a tightening environment in order to actually slow the economic conditions in the economy. And so inflation is still a little too hot. Hasn’t tightened enough to slow the economy. And so the expansion continues. We’re starting to get to the difficult point of that expansion where we’re going to have to tighten money more.

Either the Fed will have to do more or we’ll have a market based tightening with interest rates, long end interest rates rising, which will create a tightening of the economy. Which will create a hit to asset prices. And so that’s where we’re at right now is that classic late cycle moment of the economy’s too hot, too sustainable, we need tighter monetary policy and it’s gonna come one way or the other, either from the Fed or from a market based type.

Ben Fraser: Yeah, makes a lot of sense and definitely aligned in a lot of ways. It’s interesting ’cause I think, we’re rewind the clock. Not even 12 months ago, everyone was worried about recession, right? This is the fastest rise of interest rates that we’ve seen in history. And oh, they’re going to shock the system.

This is going to cause a massive, fall off a cliff scenario like we’ve seen in the past. We haven’t seen that. And to your point, we’ve seen very strong wage growth. We’ve seen costar consumer spending. And lower household debt service, et cetera. All these kinds of things are creating the foundation of a strong economy.

Are you seeing, what type of recession, if any, are you seeing, do we hit a soft landing or does this kind of just get prolonged a little bit as we’re in this weird space of economy is still growing, but, asset prices are coming down maybe at a slower rate than this rapid fall kind of domino effect scenario.

And do we just slowly hit the bottom and then, things take off from there? Do you see there has to be a reset in a certain part of the economy or asset prices for this to kick back into the next, to get into the next economic cycle? 

Bob Elliott: Yeah. I think the core challenge with the current economic environment is that inflation is too high and it’s too high.

And I think we can all focus on all sorts of things. Nitpicky details about exactly how CPI is measured and this or that. But I think certainly if you talk to anyone on Main Street, they’d say inflation is too high. And is a persistent consideration and influence on activity. And that’s a problem for the Fed.

And it means that in order to address that problem, they’ve had a lot of benefit from supply chains healing actually from a fair amount of labor supply occurring, both from people in the. Domestic residents basically coming into the labor force as well as an inflow of immigration, but we’ve exhausted those I’d call easy ways to deal with inflation, the inflation problem, and now we get to the tougher points to deal with the inflation problem, which is basically this tradeoff between, are we going to accept an environment where measured inflation is three to 4 percent relative to the feds target of two?

Or is the Fed going to do something, or is the, frankly, the market going to force a set of actions by raising long term interest rates? Are we going to have bond vigilantes basically come back to basically create a market based tightening if the Fed won’t do it to bring that inflation down? I think that’s the key question.

If that happens, it can, we could either have an okay moderation of economic conditions to bring inflation down, But it’s, that’s a very risky moment because it could also lead to a circumstance where we get a self reinforcing negative environment and that could create a more meaningful downturn.

That’s going to be challenging for the Fed to refer to. 

Ben Fraser: Man. Okay. I have to have you back on and talk just about back hookers. I could do that all day long, but coming to the end of the time here. 

Closing Thoughts and How to Connect with Unlimited

Ben Fraser: Bob, thanks so much for coming on. Really fun episode. I enjoyed this. And what’s the best way for people to learn more about Unlimited and the models that you guys are working on?

Bob Elliott: Yeah, if you want to learn more about Unlimited and our products check out https://www.unlimitedfunds.com/ where we have more information and a relatively regular blog where we’re talking about alternative assets and some of the considerations, the portfolio construction considerations there.

And if you want an ongoing flow of takes around the macro economy and markets. Definitely check me out either on Twitter at Bobby Unlimited or on YouTube where we have clips of regular appearances as well. Also at Bobby Unlimited. 

Ben Fraser: All right. Thanks so much for putting some of those links to the show notes.

I appreciate it, Bob. It’s really fun. 

Bob Elliott: Thanks so much for having me. 

Ben Fraser: This is the Invest Like a Billionaire podcast where we uncover the alternative investments and strategies that billionaires use to grow wealth. The tools and tactics you’ll learn from this podcast will make you a better investor and help you build legacy wealth.

Join us as we dive into the world of alternative investments, uncover strategies of the ultra wealthy, discuss economics, and interview successful investors.

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