Nobody is prepared for a 2nd leg down, with Ari Bergmann of Penso Advisors

It’s not every day you get to sit down with a Volatility veteran with over 30 years of experience…..Well, maybe it’s a bit more common here on the Derivative than elsewhere, but we’ve got a special treat with Ari Bergmann(@AriBergmann) joining Jeff on this week’s Derivative episode. Listen in as they dive into where to find convexity, why that’s not the same thing as buying lottery tickets, how there’s a difference between a low price and a value, and the processes needed to maintain portfolios of convex instruments. Ari is the Founder and Managing Principal/CIO at Penso Advisors, where he leads the firm’s investment committee and manages various Penso funds and clients’ mandates.

Ari and Jeff are sorting through all of the Volatility mumbo jumbo and taking a closer look at the practical limits of cheap convexity, where imbalances come from in residuals and structured notes; how the ignorance of the possibility of a second leg down formed and still exists, trading complex options vs. vanilla options, the importance of monetization, and so much more! Plus, Ari is giving his hottest take on gold and why it’s crucial to keep your personal life private — SEND IT!



Check out the complete Transcript from this week’s podcast below:

Nobody is prepared for a 2nd leg down, with Ari Bergmann of Penso Advisors

Jeff Malec  00:07

Welcome to the Derivative by our RCM Alternatives, where we dive into what makes alternative investments go analyze the strategies of unique hedge fund managers and chat with interesting guests from across the investment world. We’ve managed everyone to world ampersand de Nine, eight, I guess because when you write an eight sort of looks like an ampersand, all I want and I’ll allow us to bring on a few fun guests over the next few weeks, we’ve got the guy who taught Finn to it. phenom Chris Abdo Misia the derivatives ropes, talking about a market making game he designed one. And then one of our favorite trend followers Eric Crittenden. Didn’t have standpoint funds to talk through what’s next in that space. But up next for you is a real treat. We’ve got the Founder and Managing Principal CIO at Penso. Advisors Ari Bergman On this episode, don’t let his folksy voice and style fool you are is as smart as they come in terms of structuring trades where you can find cheap convexity, which is exactly what you want when and if there’s a second leg down, send it This episode is brought to you by RCMs vix and volatility specialists and it’s managed futures group. We’ve been helping investors access volatility traders for years like penciled in can help you make sense of this volatile space. Check out the newly updated vix involved white paper at our under the education menu, then white papers like and now back to the show. All right. Welcome, everybody. We are here with Ari Bergman. Welcome, Ari. Hi, how are you? Good. Thanks. We were chatting a bit before we got started you there and toasty New York. You sent warm today.




Ari Bergmann  01:46

That’s it. Nice, warm and humid.


Jeff Malec  01:50

Where do you escape the city for in the summer anywhere?


Ari Bergmann  01:54

I went. I just got back from Panama, actually, with the kids of my grandchildren. Yes, it’s fantastic. People don’t know it’s a hidden jewel, really?


Jeff Malec  02:03

Similar to Miami or more culture, I’m shimmy.


Ari Bergmann  02:07

Yes. He’s much nicer in there, ma’am. In many aspects and has lots of nature. I think that you will go from the Caribbean and islands in the Caribbean to the Pacific in 40 minutes. And that’s it for me to drive. And that’s fantastic.


Jeff Malec  02:23

Yeah. And I gotta read up what they’re doing on the canal, right? Are they expanding it or that’s already done? They did.


Ari Bergmann  02:29

They expanded the canal. The canal is going full force in the sitter’s you Mungus boats going through, and it’s human nature. Really. It’s amazing, right. And if you do surgeries, it is nothing just understanding the force of death, the eighth wonder of the world. Yeah, it has been growing stronger and growing since 1914.


Jeff Malec  02:48

Since 1914, yeah, yep.


Ari Bergmann  02:50

That’s how the canal was inaugurated. 1914.


Jeff Malec  02:54

Wow. And if you can give us a little bit of your background, so you’ve been doing this volatility mumbo jumbo for 30 plus years,


Ari Bergmann  03:02

yes, of doing the mumbo jumbo letter because I joined. Yes, I joined Becker’s choice in 1989. And the realist since then maybe saw many developments, many issues, and the opportunities, and it’s great.


Jeff Malec  03:20

So what were you doing back at Bankers Trust,


Ari Bergmann  03:22

just so big trust, I joined in as an associate right, the bottom of the totem pole, I joined the interest rate derivatives trading desk. And then I came to run the desk during 9293 94 became a partner bankers drawers. And I was doing them. So I basically started from 89 From the bottom of the totem pole in interest rates, to actually running the desk in interest rates and then moving becoming a partner and running in equities, more on the strategic side. Do we acquisitions, doing m&a transactions or using derivatives and that when I netted seven, I left my open loan business and has been good


Jeff Malec  04:13

and what happened? There, you’re no longer they got gobbled up and some acquisitions and whatnot.


Ari Bergmann  04:18

Yeah, yeah, I left and benchrest was got acquired by Deutsche Bank. Bankers Trust at that time first. And that was the actually acquired Alex Brown, right. And then Brexit has some troubles and this and that, and that, finally, they got acquired by Deutsche Bank. So that was a time that our family


Jeff Malec  04:38

was invested. And then started your own firm went right into Penso.


Ari Bergmann  04:42

It this time was called setting advisors. But then I realized they said to me, we had been used by so many people. So we follow the in pencil. And an impasse is very interesting, because the first person to talk about derivatives the first book is actually one it was written in the 70s interest 1688. And it’s actually one of the 10 best books ever written on the financial markets. And what was written in Spanish about the trading of the company of the West Indies in Amsterdam, the stock market in Amsterdam, it’s called, by the way, that name is amazing. It’s called confusion, confusion, the confusion is confusion or confusions, right. In the market, he talks about remedies towards calls for his crash. And that was actually one that was actually the first book on the financial markets and it was on the rivers. And it was basically 100. And some ideas before the vision of calculus, right calculus is Life is a new thing in the 18th. A much later, so 50 years later, so this is pretty good at a time. Yeah, so. And it was written by a guy called pencil de la Vega. And so de la Vega. That was his name. And we took the name pencil. So the name pencil is an allusion to pencil omega. He wasn’t the forefront of the rivers. He broke 698 The next book in the financial markets is 50. Right, Robin Makeda for the markets, but there was nothing and he’s still the first book on the market financial markets first because the revenues and one of the 10 best books ever.


Jeff Malec  06:30

All right, I gotta add it to my list. And what’s he talking about? Were their actual derivatives on the South Sea trading company at that time, or he was saying,


Ari Bergmann  06:39

the West Indies though. You describe these descriptive, not prescriptive. It’s descriptive, right? He’s telling you what happened there will futures they were put in, they were close. And they were training. And people priced it not using Black Scholes or anything like that. Just priced given their God. And it’s amazing how close they got to a what’s called the closer formula. See that? They This is truly something that we know the wisdom of the crowds, right? That the crowds can price stuff, intuitively, sometimes better than the most sophisticated models. And we see that they had the first crash, right when they work at the West Indies were losing their colonies to the Portuguese. And they had the first short selling ban. And that didn’t work. So remember that in 2008, we had a short selling ban. Yeah. So I was just hoping for this had been tried in 60 days didn’t work,


Jeff Malec  07:39

then when it seems like that’d be the perfect stock for an option, right? Because the chip would come in or not come in. So it’d be like a built in exploration.


Ari Bergmann  07:52

Absolutely. And not only that, if you got information, if you got some kind of a rumor that they were pirates taking over the boat or stuff like that, so it doesn’t fascinate these confusions or confusions. And it tells you the rest goes and all the people playing games do or didn’t change much. We had mean stocks today. We had today the short squeezes. We had short squeezes it means tax at that time. But it was only committed diversity this


Jeff Malec  08:20

the reminds me of the Baron von Rothschild who had was the world’s first high frequency trader, right? Because he had the carrier pigeon was fast pigeons. Absolutely. The foot messengers,


Ari Bergmann  08:32

yes. But it was later right.


Jeff Malec  08:35

So he knew Napoleon lost before everyone else.


Ari Bergmann  08:38

Yep, yep. So this is way before but going insane. And Newton and Leibniz were at the time working on on calculus. And this stuff was already being used.


Jeff Malec  08:51

I love it. Well, listeners, everyone go add that tier reading list.


Ari Bergmann  08:58

Right. And it was translated and Abraaj into English. It was done by Harvard Business School, Harvard was the one one of the professor’s did a abridged Vision version in English because it’s written originally in Spanish. It’s a much larger book. And it’s fascinating.





Jeff Malec  09:18

Hello. And so when you first started, were you saying hey, I want to be this protected piece of the portfolio? Or was it more of a absolute return and we want to do you know, be a hedge fund that makes tons of money for our investors. At


Ari Bergmann  09:32

that time, when we started is doing what we do best is finding what’s called cheap convexity. agnostic to risk. And the reason the way how we started going into this idea of hedging the tails was actually only in 2006 2006. It’s on the market, very much like today. We sensed that there was a lot of was a bubbling market at that time you had even published read that it was Warren Buffett’s famous line, the times of greed be worried. Right? And that was extreme greed. And even Bridgewater at that time has investments today, right? shown how much or what spreads came down and how balance sheets looked at, we saw what was going on in the housing markets. So we said, okay, the time is to create for our own portfolios, a hedging system that will take advantage of a tail event, we started to talk the six. And it was, like, God looking back perfect timing, but who knew at the time, we thought that the time that could take as long as two years for something to happen? Exactly today.


Jeff Malec  10:46

So you were you weren’t early? You were a little early, but pretty much right? Yes,


Ari Bergmann  10:51

the key is because you see, the most important for a hedging for stuff like that, is that you can be too cute on the timing, right? Because it’s very, very easy to lose the opportunity and hedge hedges are such that it’s available until it’s not. And once the hedges are not available. That’s it. It’s too late. So we started too early, but it’s okay. And with these things will price right away. And the main, I think that the most important aspect of any hedging strategy is you cannot depend on timing, just to be very careful about the budget, not to spend too much to realize that you have to have a horizon. And at that time, you said, Okay, we are ready to be in this for two years, it will take at least two years for something to happen. We will look at it took shorter.


Jeff Malec  11:40

I think for the same timeframe, The Big Short book, right taught everyone that of Michael Burry, like almost ran out of money trying to hold that hold that trade.


Ari Bergmann  11:49

Yes. And I think that this is a very big lesson. But we were very careful that that’s why we never bought CDs on the housing market was too expensive. Yeah. So that doesn’t make any sense. Right. A, it looks good. But we always look for convexity, which means to find stuff, that doesn’t cost much that allows you to hold it. And it has a great multiple that is where we come in and that we knew that at the time. So this idea that you almost ran out of money. It is interesting, because a lot of people did run out of money, right? Yeah, this is a I was looking at histories made out of the winners, right? The conquerors, you don’t know how many people like him. Were also right on the idea. But they were dead. By the time it came. We actually thought the sixth one we did we bought a huge CDs portfolio. We did not buy on the housing because made no sense. We said you know something? Let’s look at the next vulnerable link in that chain, which are the providers of liquidity. Forget about the people will be borrowing, we will be lending. And at that time, it was extremely cheap. Price was 25 basis points, right. But we actually bought it from somebody who had hedged throughout and lost so much money they had to bail out. So we don’t know how many people were like Ron Barry, but the only they just lost and got out of the game.


Jeff Malec  13:21

Yeah, that’s he’s usually considered like a genius. Right. But it sounds like we’re saying, hey, he maybe he is, but he chose one of the most expensive ways to get the convexity


Ari Bergmann  13:31

there. And he was almost out of the game and never confuse luck with genius, right? Yeah, that’s it. I think it’s very good. But that genius, everybody, which basically comes back to this idea, right? You never want to be dead, right? Better to be dead. Wrong. Dead wrong means you’re dead for the right reason. But if you’re dead, right, you’re dead for the wrong reason. They’re dry. It means that you’re right. But by the time it happened, your dog dead. Yeah. And you’re there for the wrong reason. Because you’re right. It shouldn’t be that


Jeff Malec  14:06

way. There’s flipside of that is fail fast. Right? Yeah. How do you so if you started out and you’re looking for cheap convexity, right, how do you kind of put the guardrails on that anti limited because I would be running all over the world saying, Hey, we can get these French electricity prices and this spread and that gas and, you know, there’s so many trades out there that you could structure that could provide that cheap convexity. Kind of, how did you go about figuring out okay, how do we want to approach that? Where are we going to put the limits on that idea?


Ari Bergmann  14:41

Okay, first of all, what’s very important is a lot of people confuse cheapness with a low price, which is called the lottery ticket phenomenon. Okay. Looks look at that lottery ticket, right? It looks cheap, but it’s not cheap. It’s a low prize but it’s extremely expensive probability speaking your mind for $1 something that’s always the results, if you’re lucky, 30 cents, probably worth 10 cents. Yeah. So that’s not cheap. It’s a low price. So in the world, number one, you’ve got to look for opportunities, but you have to be smart, most people so well, I could buy a lottery ticket here a lottery ticket, there is just a very big, much of a waste of time and waste of money. So you have to be careful to measure. That’s number one. Number two, you have to have a budget. And you have to be very, very systematic and very disciplined, and very structured to do the hedging, which I mean to say is the following. Just buying stuff out there lottery tickets and see what works. I can tell you, it never works. You only see a result, you see we are very much resulting look at like, the biggest trade ever. And it’s BS, right? Because you’re taking one guy that was lucky and survived, you don’t see how many people died? And how many people lost all their money. Yeah, right. So that’s resulting, resulting is inevitable process. So therefore, when you look for trades, the number one is to be very, very systemic, systematic, and very disciplined, very structured. And that’s what we do, we say, Okay, we are going to look for scanning the world, for two types of trades. One of them are called the proactive, we have risks out there. Let’s say we look at the housing, let’s look at the most effective trade to give me returns, if that happens. And you have scan the world. And what you don’t want to be right, you want to make money to be right. It’s great to put a book, but your investors never make money. So therefore, you have to say, Okay, where can I find a trade? That’s long enough, that gives me time that there is a multiple that if I’m right, and not making money, I make new multiple the money. That’s what it takes. So you have to be smart, you have to be structured. And that’s what’s important.


Jeff Malec  17:12

Yeah, I think of it like parlays in football betting, or we could use the craps table, right, or like, oh, there’s great odds on those double sixes. But no, those aren’t the true odds that a low price but not a good value.


Ari Bergmann  17:27

And that is the key way people lose so much money. Because people are they don’t have structure or they don’t have a unit of a structure, you need to have a process, you need to have a budget, you need to give yourself time because timing is the worst. And you want to make sure that you don’t blow up your chips in the first game, because sometimes it takes many innings to get to the final result.


Jeff Malec  17:50

And so who who were selling you those, so you’re basically buying these cheap, cheap convexity, or, and those are usually in options. Correct.


Ari Bergmann  18:00

Usually in options format, not always. So there’s swaps, but usually they are not people betting against you. Those are residual risks of trades, because you look at what the replays are fascinating is that is basically taking an acid and carving out the risks turning an acid, one acid into a basket of risks that you buy a bond and you buy a bond, you have interest rate risk, right? Because if interest rates go higher, you borrow money, but if credit risk, you have currency risk. So one bond has many risks, so you could carve out so people banks do structural products for their clients all the time. And they are left to residual risks. We take advantage of that. So people are selling those protections, not even realize that they’re doing that. And that’s called the residual and that’s what we look for the non obvious risks that people are selling, without even realizing and that’s why they’re so mispriced.


Jeff Malec  19:03

Yeah, but it seems to me in this day and age after so many books after so many people highlighting those that they would catch up, right that these banks would catch up and be like, Okay, I understand that there’s brisket, sir. Yeah, they’ll not get it or are they just greedy and say, I don’t think it’s gonna happen.


Ari Bergmann  19:20

Is that because they don’t see the I don’t think anybody does that first of all, the opportunities are still there even more than before, because actually they are not taking that risk, they are passing on they are creating the more this product became more these books exist, right? They create all this product and they sell what they sell product, they are left with residual risks and many times without people realizing them. You have very mispriced residuals and that’s what we do. What we thrive is that’s why hedging cannot be done as a hobby. It cannot be done by people who don’t want Standard, because then you clearly are going to overpay. Because like you say, anybody today who sells you, there is a reason why he sells you. Right? Because it’s now worth it. But you have to look at the residual risks. residual risk is basically when you build something, there is always left over if I was to say, if a guy walks with gold, right, it makes gold jewelry. The dust of the Gold is gold. Just people don’t realize, yeah, that’s the key. When people do it, derivatives, derivatives are tools that they create instruments, and because of the books and etc. These tools are very, very cool. When people make money and people lose money, in the end to answer make my advice. And they are like, anything, they create stuff. They sell this coach structured products, most important structured notes. But the dust that’s leftover, the risks, those are the most mispriced. And people don’t even realize that they’re selling out of the money stuff, not realizing.


Jeff Malec  21:05

And so the buyers of those, you’re saying so if I’m in where this is big in Asia, it’s getting bigger in the US, right? I think we’ve seen record number of structured product issuance. So that’s what you’re talking about. It’s getting more opportunity, right? Create opportunity. And so give you an example of some of these structure notes and what some of those residuals, they throw out the correlations,


Ari Bergmann  21:27

the correlations, some people bet the Quanto notes, some people say, Okay, I want to invest in Europe, in the DAX, but I want to invest in dollars. I don’t want to make things in euros because I don’t like the euro. Yeah, that by nature, you’re doing a correlation trade, because you make money in dollars. And you lose money in the s&p indoors. So he tells you that you could have a higher dollar lower deck straight out there, that the guy by nature is selling because you realize that by doing dollars. In essence, the dollar will appreciate more when the market goes down. Yeah. So if you took downside indoors, you’re losing more and more money as it goes down. So that correlation, the banks take advantage of it. And this


Jeff Malec  22:25

because they don’t want that. Right. So there’s but they’re taking on that risk by selling it to you they sell


Ari Bergmann  22:29

into yes or no, because they are offsetting the risk that they did on the structure notes.


Jeff Malec  22:35

Okay, so they’re long that risk, they’re selling it to you now you’re long that risk.


Ari Bergmann  22:39

That’s it. That’s always the case. Always the cases that are out there, the correlation books, these books priced as residuals. And that’s what opportunity shows?




Jeff Malec  22:49

And is it the case? It seems some of the conversations I’ve had in the past, some of these banks didn’t quite know what they were doing as they structured these notes or a new team came on. So you can a little bit take advantage of the banks.


Ari Bergmann  23:01

And the incentives are they think Santy Saturdays, the banks, they want to book the profit right away? Yeah, they had when he talked the Cubs, the headache, the guy who got the bonus is long gone. That’s like, it’s like the government, right? You have the guys who are elected, they create a mess. The short term gains for the long term pain, tobacco exactly the same, the short term gain from the ultimate pain, and we take advantage of the ONE campaign.


Jeff Malec  23:29

And where do you stand just as we’re on structured notes, add this later, but we’ll touch on it now of Do you think this growing popularity of them is a long term problem that it could cause some cascading effects? Or do you think the other side of that would be no now these banks have so much that they have to hedge that it can pin the market at certain levels? What’s your take on that?


Ari Bergmann  23:51

I think either way, I think that depends on the risks depends on the market dynamics, but the market does in such a way that is going to hurt the most people the most time. So I don’t think I think that the risks are people are focused on really never happened the payouts because people are so actually that’s the big supposition. But at the same time, what’s something that people are not prepared for? can have a much more cataclysmic effect? Look at what happened COVID COVID was something that came out of the Quantico blue he made a lot of money because people are not expecting always the market. I think you have to see a lot of people spend too much time trying to dominate the market to see okay, what will happen and the reality of it is the great risks are the things which are people are least expecting.


Jeff Malec  24:51

You guys have some great slides in your decks have these second legs down and I kind of view your product as something that protects against a second leg down Yes, probably 80% of the investing world right now has never seen a second leg down. So


Ari Bergmann  25:07

I would say more, Jeff, I think 80% of the people don’t believe that there is a possibility of a second wave. Not only they’ve never seen it don’t believe in it. They think that the central banks are omnipotent. They have unlimited powers to prevent a second lag,


Jeff Malec  25:27

which they’ve been proven right. So that’s the Debian proven right?




Ari Bergmann  25:30

Yeah. But past performance is no best history is never a guarantee of future performance. But that would create something called complacency. If I can tell you one of the most dangerous, mispriced misunderstood, risks out there is the second leg. And the second lag tells you that aftermarket declines, right, like he did in Japan, let’s say in the 90s. Right. boj was there. So the market had a huge rally declined, and then bounce back, because this mentality of buy the dip, right BTD has worked, you just go, and it’s an easy one. Everybody goes,


Jeff Malec  26:18

I think they’ve been answered up to BT F D. But we won’t use this way where it’s


Ari Bergmann  26:23

here. Yes, we’re trying to cleave a very clean, good G rated. So you have this thing, and people buy it. But then if there is a challenge, when the market doesn’t rally enough, and the rally fizzles that happened in every market, I’ve seen this from the self esteem levels that people are used to divided until it didn’t work. So then the market realizes that their assumption isn’t right. And the second leg is the most painful. And the reason is, for a couple reasons, because not only the people they didn’t sell by the first need to sell. But a lot of people actually bought more when this thing dipped, and now they need to sell. hedges are not available, because hedges have a long memory. So volatility lingers. So people don’t have address. So short address, we are very positioned for that, because we are by nature, multi asset. So you’re always looking for opportunities. And there is always opportunity that if you focus on, let’s say buying puts on equities, they might not be available right now that 30% And the second leg is the most problematic, more people need to sell. People aren’t expecting that happens. And that I think we’re going to see and if you were very close to a second leg event, and the reason is because the central banks have basically pushed themselves to the limit, which we’re seeing in inflation, inflation numbers, you saw that after COVID. Their balance sheets double from 10 trillion to 20 trillion. Right is a hockey stick. And there’s so many imbalances and Hoenig. Right, one of the Fed governors was against QE, right. He always said there is a great book called Lords of easy money, lords of easy money. And that’s holding saying this QE, it’s easy to get in, it’s impossible to get out. It’s like, basically you have pregnant, there’s no way it’s too late for abortion, which means right which doesn’t go. So therefore they balance sheet growth, and is in such a way that you just don’t have a way to get out. And therefore, okay, the second leg is very, very possible, we are as close as we have ever been to a second leg. And the market not only hasn’t seen that the market has this secured feeling that this will never happen because the central banks won’t allow. And their mistake is threefold. Number one, maybe the central banks have a different view of how far they put out by the famous central bank, but maybe we’re out of the money. Number two, they might not be able to do it, right, either because there is political pressure because there is inflationary pressures. Or just because there is a currency war I guess they won’t be allowed to do it. So in other words, maybe they won’t do it because either because they don’t want or because political pressure or because they can’t. And the third one, which is even the most problematic is at some point in time. Even they do it won’t help because they will lose credibility. And in a world that there is such balance sheets, there are so much inflation building the bond vigilantes which we’re seeing them coming out, there will be the first Who wants to? not allow? So in other words, you could have them buy bonds and rates going higher?


Jeff Malec  30:09

Yeah, it seems so and even in this environment, right, we got this quickly the narrative change to Oh, the Feds gonna pivot. So it’s just we’re created the Fed put out and nothing of like they’re gonna pivot.


Ari Bergmann  30:21

Yes. And I think that we are up for I told you, this is why investors need to hedge because I’m telling you, one day, you might look back at it and say, My God Almighty, so obvious that people keep drinking the Kool Aid until they can’t?


Jeff Malec  30:39

And how do you define the second leg down not in terms of like gets from 20 to 40%, or just that environment where people, there’s no more hedging available, there’s no more liquidity, it’s a cascading effect as a cascading


Ari Bergmann  30:52

effect. And it goes very quickly down. And he goes on and stays in usually takes the recovery from there to the bottom high seven years.


Jeff Malec  31:02

So oh, wait, like that.


Ari Bergmann  31:05

The oh eight was a type of second leg down. But they were all the times. In Japan, the third in Japan is the classic one, they the 2000s. The one two or three, remember, right, the market at big rallies, then just came down. And it was triggered by WorldCom. You always have something that triggers, right, you always need a trigger. Had a


Jeff Malec  31:31

I think I told the story in the pod before but I had a friend who used to work at Worldcom in New York there and their biggest client was Jordan Belfort. Do it from the boiler room? Right? Their phone bill said was to two feet thick, because they were just calling every house in America. Yes. So. Okay, so no wonder that it was not a solid market?


Ari Bergmann  31:52

Yes, it’s a very interesting aspect. And you have to be very careful because as you know, these things can be very problematic and very big issues.


Jeff Malec  32:01

And so what types of trades when you’re thinking about, okay, I want to prepare my investors for a second leg down that nobody’s worrying about nobody’s thinking about. But perversely, like there’s still a lot of a bid for far out of the money puts right?




Ari Bergmann  32:15

Out Of Money puts don’t work, they’re very problematic, right? Auto money puts a very problematic, but you have to scan all assets, all asset classes. And when you scan all asset classes, you get to see what they are and has to be something which is not obvious. And clearly we cannot go over trades to tell because there is already available, but that’s why people pay us but we have to scan and you have to find something which is not obvious. And many times okay, just look at it. Bad movies are not fire hazards. Only good movies are fire hazards. Now there if you go to bad movie, and there is a fire, who cares a Five Guys just look at the door. Yeah, if you go to good movie, and there’s a fire hazard, you’re dead, which means that the bad trades, right, which shorting bad stuff never helps you because nobody’s in there anyway. So you have to be very contrarian. So that is you’ve got to scan the US and you have to be very, very, very, very disciplined, methodically, go through a lot of stuff. And you have to divide, we divide the hedging into two buckets, one of them is called proactive proactive means we’re hedging a specific risk. Most of our portfolio is reactive stuff that we believe that perform if and when the market tanks it’s react, I don’t care what it it could be a bolt of lightning, it could be Martians coming or it could be that they found the who knows what they found the new COVID variant of it doesn’t matter. Because for us to be just proactive to look at risks a pot if you watch a pot boil, it will never boil all those quote unquote obvious risks never work.


Jeff Malec  34:08

And so sort of by definition that introduces basis risk against your s&p holdings are one that right so the non obvious hedges are going to have basis Risk of Rain. We’ve seen that this year if you thought gold was going to protect you against inflation, if you thought bonds were going to protect you against a down market right yep, took on some basis risk neither those work. So absolutely. So how do you do that? How do you control that basis risk? Is it just a price of doing business or


Ari Bergmann  34:34

no you diversify, you know that if you diversify, well if you have enough if the convexity is mispriced, you are so we always have those are some of the 60% which is not work. But the winners carry everything. You can never assume that all of the work because it won’t. If you put all your eggs in one basket Murphy tells you that that basket will crush We have nothing


Jeff Malec  35:07

but talk a little bit about these dual Digital’s and complex options versus vanilla options. So that’s another way to do it. Right, you’ll get more convexity there. Because two legs of the, what I call the parlay have to come in instead of just one. Right, right this year that was, hey, if bonds are down, stocks are down in a dual digital that paid out way more than if you’d done each separately. Yeah, that is true. So how do you that’s just part of the math there of okay, these things to have better payoff structures, then vanilla?


Ari Bergmann  35:37

No, but many times there are bad trades, because it’s hard enough to be right on one thing, which is hard on two things you have depends on the correlation. It’s all a mathematical game. I told you, this is not anything that’s too obvious. Ingo to work.


Jeff Malec  35:54

And then what about the counterparty risk? So some of those are offered by these banks? Well, not that you’re doing. So you do a lot of exchange traded stuff, but some OTC as well.


Ari Bergmann  36:02

Right. So the OTC the only way to do it is number one, you’ve got to have two way margining. So imagine it every night, we post to each other. If they owe me money, they pay me overnight. Because you can never take more risk than overnight. You cannot hedge. If you remember the movie, Fargo? Yeah, they remember the guy goes to ask about a loan and he says Who guarantees it’s okay, I guaranteed. So the Fargo guarantees if you buy stuff with the bank, because the bank may or may not be there. So the only way to do it is number one, have a very efficient, cross margining more daily mark to market number one. Number two, you need to diversify your counterparties, you can never have a lot of concentration risk. Number three, you need to constantly monitor the changes in your counterparty changes, Delta ratings, risks, stuff like that. So three things. Number one, daily market markets, you can never take more than what’s called overnight risk, which is still a lot overnight risk, right? You have to maintain very carefully, you got to maintain very carefully your counterparty exposure. Number three, you need to monitor them on a constant basis.


Jeff Malec  37:28

And then speaking of so bread, that if if their hedge doesn’t pay out, you’re not hedged is the obvious part there, but kind of built into the same thing. And let’s talk a little bit about monetization. So right, a big problem with hedging with these is when do you monetize them, if you don’t write in March of 2020, if you didn’t monetize, you might not have gotten the opportunity to buy back into your stocks. So talk a little bit about how you guys view monetization, when and where you do it.


Ari Bergmann  37:55

We think the monetization is the most important part of the business, you have to have a very, very clear, and a very well defined strategy, we do have that. And that’s defined in various aspects. But it cannot be left to total discretion. We have a system, we have a method. And we have models to tell us, I think to put on hedges, it’s actually easy. The tough part is how to monetize and not to be exposed because you monetize too early. You are exposed, you’re naked, because this thing can go to second leg down. You have nothing left. Yeah, if you don’t monetize, and just go away. So what sets apart the men for the boys is the unsession. So it has to be a very clear, defined methodic way of doing it. And we have a very much of a defined method. Plus you need a lot of modeling to signal when the monetization and then you have to know how to replace what you monetize.


Jeff Malec  39:09

Which of those is harder that third the last seems the hardest, right? No, no,


Ari Bergmann  39:14

I think there was no hard there was no easy. There was no easy everything is hard. But life is hard. Don’t want an easy life. If your life will be easy when available. We are only here because like it’s hard. Yeah, so hardship is good. I think I always told you, I always tell my kids don’t ever expect an easy life. You don’t want a nice life. You want a meaningful life. The hard life, it’s fine. Challenge always good. So it’s not harder or easier. Everything is hard, but everything is if you do it right. There is a process that process laborious, it’s very important. And the three of them as as hard as a laborer is but if you ever system, you have a process that’s well defined ahead of the game works. And again, not be by chance, don’t ever do it. resulting, just because guarded, right once you realize the market allows you to feel resulting right? If you get right once you think that you have it. And then when it comes, you just miss it completely. So you have to have a process, a very structured process, very clear process. And besides that you need to have modeling to allow you on a very much systematic way to flag what’s called the monetization windows.


Jeff Malec  40:30

And as it I’m sure it helps that you guys are in all these different markets and Digital’s in cross so you have a much larger dataset than someone who’s just trying to model it based on s&p and Vixen, right, there’s not enough observations to really build a model on when to monetize.


Ari Bergmann  40:45

Absolutely. And not only that, if you do only one asset class, you don’t know what to replace with. If you monetize that, so what life is good, then life is gone, then you might be lucky, or you might be very unlucky. Right? Don’t, you cannot build a strategy on luck. It’s great to have luck, but you can’t countenance


Jeff Malec  41:07

and talk to you guys talk about your attachment points from time time and your stuff. So this comes in at the same level, as tied in with monetization.


Ari Bergmann  41:17

It’s tied to the monetization, but it’s not the only one. Now, because sometimes he gets to the demo, monetization the first level. So you have to monetize once you get to the first attachment point. But then you have to know how to replace because a second attachment is all possible. And many times you get to monetize along the way you just can’t, because you might not get there. What happens if you do short with the first attachment point, and then it disappears. The market doesn’t let you do cute stuff. cute stuff. It’s cute, but doesn’t make you money on a systematic way. So you might be lucky Don’t be resulting. There’s always one lucky guy who says, Oh, I have the best trade ever. That doesn’t mean anything. It means the process. What’s important is the process the process, which is repeatable, that you’re not relying on luck, there is luck. It’s always great, but you can’t rely on it. So therefore, on the first attachment point, are among decision windows, you need to replace it. So you need to find something to replace, if you have only one asset class, how are you going to replace it? I don’t know, they have a desert. But it did multi ethnic class multi structure more diverse, you are the easiest place. That’s the replacement theory. Number one. I think it’s also very, very important to realize that you need a method monetization method that goes along the way you cannot wait on four decimal points, because you might never reach their annual opportunity.


Jeff Malec  42:40

And in the concept of attachment points is I don’t care if my attachment points negative 20%. I don’t really care what the markets doing between zero and negative 10%.


Ari Bergmann  42:53

You do care, right? If everybody cares. But the attachment point is that’s a target return. You should make some money along the way. But not always depends. Yeah. But the attachment point is gives you a benchmark of what you could be. And those are bigger events, a small move, mentors random. The vagaries of the market


Jeff Malec  43:23

mentioned earlier you have basically a set premium spend they’re going to spend each year and then do investors have to read top off their investment. Right. So a difference in some funds that say, Hey, put it here, we’re going to offer this tamper protection and we’re going to try to limit bleed. And you just put in the money and it lasts for 10 years. This seems more of like this is an annual premium spend to protect your portfolio.


Ari Bergmann  43:48

Yeah, but we don’t look at reverse, but we want to minimize, we want to work on it. But you might not be able to you might not have to top it up but you should always top it up. You should always rebalance your portfolio. Let me give you an example. Let’s assume that the portfolio or the hedging was perfect Dean was any money but your equities were up 30% You need to top up because if you want to maintain a 97 three you need to rebalance. The rebalancing between the portfolio and the hedge is extremely important. And allows you also the hedge went up a lot in the equities and up you move it back that rebalancing the portfolio is a huge moneymaker. And it’s like gamma trading that option. Yeah.


Jeff Malec  44:32

The end was this is similar to universes model from what I understand what


Ari Bergmann  44:37

I not sure of universes model but these were our model is very different than their business. No,


Jeff Malec  44:42

I mean, just what the 97 three was what triggered


Ari Bergmann  44:45

97 Three years, but again, I’m just using it could be that 73 could be 92. Again, depends.


Jeff Malec  44:53

But yeah, it seems to me balance.


Ari Bergmann  44:55

You need to be systematic and you need to be methodical and you have the emphasis and do it right Right. Because you don’t want to. The beauty of it is if you do it right, it is we’ve seen in our hedge, right that for 10 years right for night 2010 2020. Right, with the biggest bull market forget about 2008 2010 2020. If you did, right, not only the date, the the watch of God, not only that the hedging was a creative in costume and you actually made money, your status much better. And that’s assuming that you rebalance only once. If you rebalance more, you’d have a much more money. So you’re assuming the rebalance every year rebounds by COVID. But if you rebalance in 2018 2011, you made a fortune anymore. Yeah, but it is if you are methodic, you want to make money, a good hedging strategy. We don’t believe in the model of spending money because spending money is buying insurance insurance is that investment. Our belief is that the hedging strategy has to be accretive that at the end of the game, right? Doesn’t matter how long it is, if you’re a systematic, if you’re methodical, you will make money. So the hedging not only doesn’t cost you and it makes you money, and gives you tons of opportunities to rebalance the portfolio.


Jeff Malec  46:20

So what time period over five years, 10 years,


Ari Bergmann  46:24

I would say over a market cycle market cycle is rally with default. Yep. Give an example. If you went in our funds at the worst time 2010, the beginning of the bull market. And you did and you rebalanced. Even if you only rebalanced once a year, and once in COVID, you made over that year, your portfolio made more money was a creative, much better stats. So you basically got it all for free. Plus you made money, it made you money over 10 years, the return over 10 years is more money. But not only that, if you rebalance more often in 2011, in 2018, you’re many opportunities, your returns be off the charts.


Jeff Malec  47:04

I think that’s what more less sophisticated investors would say, Oh, I don’t believe in this full cycle thing. Like I want it to be a creative year over year over year. Which that’s, that’s tough to do. Right?


Ari Bergmann  47:18

Not only tough to do, that’s not a reality, you realize, because they do that. Look at Warren Buffett, right? You make money. Like Einstein said, You we cannot ever, ever. under estimate the power of compounding, you make a lot of money. And people say wow, I made every year and then you lose all. What’s that? Yeah, this is called the main effect, right? Every year, you made money every year to sell. So then, okay. You want to be at the end of the game, the end of the market cycle is that you look at the market cycle and the world comes when everybody else is losing money, you make more money, and you have money to invest and make even more money. Imagine you rebalanced and if you bought the second exam, it’s amazing. So the year by year return is very, very short sighted. And that’s why the market provides the opportunities because most of the people who do that are going to lose a lot of money. And in the end, we’ll be the biggest losers.


Jeff Malec  48:23

Yeah, but I think they’ve been wandered out of their tail hands, right. But I think you guys have done a brilliant job of like, hey, this thing we think it’s a creative over the full cycle. That doesn’t mean you’re not going to lose most of it on in between that when the markets spike down.




Ari Bergmann  48:38

But you have to make sure that you are that you don’t waste your budget. We don’t believe in spending budget we believe in the crudo. But again, I cannot underestimate hedging has to be number one the creative the extra money at the end of the game gives you opportunities to really buy the best time possible and in the end gives you much better stats


Jeff Malec  49:01

yeah and you talked a little bit of like don’t view this as insurance or put buying so compare and contrast a little bit of to kind of classic put buying insurance vol volatility arbitrage CTA is trend following


Ari Bergmann  49:16

is different right put by is very expensive because put by can only make money when the market crashes. If it’s diversified, number one, you could make money along the way because a lot of stuff make you money no matter what. Okay. Number two, the second leg on a put by is very difficult because once the first leg happened, volatility was too expensive. Number three, it is not torturously expensive to do it unless they get the timing right.


Jeff Malec  49:45

Because everyone knows about because everyone’s in that game. Yeah, but


Ari Bergmann  49:49

not only that, you bind thoughts and most of the time it goes to blast and you have to be lucky to have the puts the right time because you might be that’s number one then The Vault arbitrage is great, but you realize that most of the times it is a crisis, the best trays that they own the loser the most money. anybody remembers Porsche Volkswagen in 2008 to two trades, that you made money made money until combat point that everybody lost everything. Folks that are getting famous arbitrage between Porsche and Volkswagen, and oil crude versus banks. Everybody’s making money by being long crude, against long, crude, short financials until the market just took the opposite crashed oil. And then the financials just went zooming. And everybody was taken out of the game. Yeah. Which means to say that this fall arbitrage it works in our system, but when there is a real systemic risk, the shorts look at long term capital, right where they logged money was the best traits, the best traits always lose you more money. And the reason is because of the crowded movie theater, much occult theater analogy,


Jeff Malec  51:08

I love that I’m going to borrow that by the way, we’re going to tie in Top Gun Maverick into that right?


Ari Bergmann  51:13

Top Gun Maverick is a huge fire hazard a lot of movies which are flying up there’s a fire you have enough time to get out you couldn’t even watch


Jeff Malec  51:25

I sit in those theaters and think the same thing of like this is I have a greater chance of like someone shooting up the place or someone do it right the more people in there getting COVID Like all sorts of


Ari Bergmann  51:35

yes,that’s exactly it. So those are the trades. So arbitrage is great, but you have to be careful that at some point in time this whole thing just and it’s called the liquidity event and the liquidity event the baby goes on the best water and the good rates go down a lot more because people monetize the good rates


Jeff Malec  51:54

and is are you saying they’re in so when Vallabh in a naive sense is short volatility in some places long volatility and others and trying to capture that so you’re saying that good trades that short rips in your face way more?


Ari Bergmann  52:06

Yeah, as long as the market tends to do that because of the good rates everybody’s saying the batteries are very short it’s cool the crowding effect


Jeff Malec  52:19

and along those lines to have you where you add on like institutional volume selling right it was big coming into balm again in 2018 it subsided a little or do you play in that game and see those flows or no,


Ari Bergmann  52:31

we see that flows but again, that has been much more things but now people people it people are doing that right now in the markets you see that in a very not on outright vowel but if you look at the vowel structure, there are parts of it that there is being outright sold. And the reason is because different reasons but the same phenomena


Jeff Malec  53:02

sent over I don’t know if you had time for your hottest take we end everyone with your hottest tech so you one of them might be that Michael Berry was just lucky. So we’ll we’ll take that as hot take one but you got any other hot takes?


Ari Bergmann  53:14

No, I’m not saying you’re lucky. Don’t tell me that. I’m only saying don’t confuse luck and skill he I’m sure he’s skilled. I’m not going to judge him. Yeah, I think the issues what I would say is the biggest contract and trade is I love gold right now. I think this is garbage. So apologies for the Miss price when they agreed to a cup of this thing is going to be so it’s something that you have to realize it is the middle sort of thing. But on the rest of it is okay for myself. Right? One of the I think the most contrarian is that think that your life you keep for yourself. Don’t put in social media.


Jeff Malec  53:49

So you’re not big on Twitter.




Ari Bergmann  53:51

I’m very big on Twitter, but he has to be curated information that you send right now on your personal life. Go Yes. Okay. It’s not the personal things. Yeah, keep it personal.


Jeff Malec  54:02

Yeah. Which is, I struggle with that, right. You gotta like Ben eifert. On one side. He’s posting pictures of his kids and his bike rides and everything but still doing great work. So modern man, yeah,


Ari Bergmann  54:14

yes. I for myself, family and life. It’s not Republican assumption.


Jeff Malec  54:20

I agree. That’s that’s the old school.


Ari Bergmann  54:23

Yes, it may be that’s contrarian, but it has worked for the past couple years of cooking with


Jeff Malec  54:28

well, no need to change now. Right. Exactly. Right. Awesome. Any other thoughts on penso? Or this market where we they


Ari Bergmann  54:36

know just to be a wish people good luck, because luck is always important. You can’t rely on luck. That’s good to have. So that’s a good egg right luck. It’s great to have. But it’s very tricky, because you start counting luck. Luck goes away. So luck is great. It’s icing on the cake. So I wish people good luck. But I’ll tell you never rely on it to a lot of work. Don’t do it. That’s it. Also don’t look for an easy life for a meaningful life. stuff, which is hard is good. Hard is good. Easy is not. Okay. meaningful life fun. Yes. Easy. No.


Jeff Malec  55:15

Well, thanks so much. All right, this has been fun. My pleasure. And next time we’re in New York, okay, you’re invited


Ari Bergmann  55:23

to come and anybody invited to come and visit us? Yeah. Boy, the heat and the humidity.


Jeff Malec  55:31

Thanks. Bye. Bye.


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