WTF is LDI, and What’s working in Vol Trading with Zed Francis of Convexitas

Cover the kid’s ears… because we’re going back to our WTF format to ask what the actual Fingazi is going over in the UK with the bank of England raising rates, then buying a bunch of Gilts to save their pensions. The headlines say it’s some new-fangled LDI concept which led these pensions into trouble. But our guest this week, Zed Francis of Convexitas, says not so fast… the LDI actually is fine – and it was the reach for yield and adding some longer duration via derivatives which likely caused most of the problems.

Zed used to work at Legal & General – which sounds like a UK pub to us, but had a solutions group which created some of these LDI frameworks, so Zed’s in contact with some of the guys on the front lines during this shake-out. US pensions also use an LDI framework…is it coming for them too? What are the main differences between US and UK? Is duration the same as volatility in these cases? Are these pensions sort of short gamma? And of course, while we had him, why is some stuff (gamma) working in the Vol space when a lot of popular VIX/Vega based models aren’t.  SEND IT!

Follow along with Convexitas on Twitter @convexitas and for more information visit their website at



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

WTF is LDI, and What’s working in Vol Trading with Zed Francis of Convexitas


Jeff Malec  00:07

Welcome to The Derivative by 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. Happy Thursday, everyone. Yep, just a plain old October Thursday, which means we’re getting on towards the end of the year. Wouldn’t surprise me to see some Christmas stuff popping up in store soon. And that means it’s almost time for our annual Thanksgiving to Christmas pod break, where we refresh the batteries and work on securing the next 11 months of great guest. Speaking of which, we got some good ones to close out the season coming up. Michael Harris of quest partners next week to talk seatstays managed futures. Then fellow Chicago and Caitlin cook to debate crypto, plus macro macro alpha if we can ever nail him down on a return of our first ever guest Wayne Himmelstein. On today’s show, where we’re bringing back the WTF episode format to hear what in the actual EFF is going on across the pond with UK pensions, the gilt market and something called LDI, or liability driven investments, who better to shed some light on LDI then dead Francis of convexity, who before he was involved in equity ball worked in the solutions group for a UK manager to ingest these types of structures. We get into how the UK differs from us pensions whether this is an LDI problem or risk management problem. And why you probably shouldn’t blame derivatives too much. We also couldn’t miss the chance to pick his brain on what’s going on in equity Volland where the gamma trades he’s known for been picking up the slack where Vega trains others are known for his struggle. Send it This episode is brought to you by RCMs outsource trade desk, which guys like dad used to get quoted up on sides and index options and work orders 24 Six as an outsourced trade operation. Check it out into the services slash trading firm slash 24 hour desk on the main navigation at our And now back to the show. All right, everyone, we are here with my buddy said Francis on a rainy Chicago day. We could have done this in person. I guess we keep saying that every time around. But maybe next year, I’m thinking maybe we’ll do some sort of like, once a month on my porch deck or some outside outside pods.


Zed Francis  02:34

I slapped my business partner Devon about 10 minutes ago to say, all right, leave me alone. And I’m ready to go talk to Jeff and he was like, Oh, you guys are doing this in person. I’m like, nah.


Jeff Malec  02:47

But wanted to get you on you guys had a super interesting post on over at convexity. Which kudos for getting that URL, by the way. And it’s a good one. Right, everyone else has convinced or dot whatever, hard to get these things. But I digress. So good post over there on all this going on in the LDI liability driven investment. In turns out before you were a equity index, option guru, you knew a little bit about this stuff. So wanted to get your talk through this was a big topic. The other week, I saw gilts went back up to those same highs I think last night yesterday. So it seems like the story is not completely over. So let’s start there.


Zed Francis  03:38

The story has changed Jeff last week is very different than this week.


Jeff Malec  03:41

Okay, we’ll get into that. So let’s start with basically what why you know anything about this, what’s your background on how you got into LDI


Zed Francis  03:51

now I’m gonna say it I mean to me the main thing about this is it’s funny because LDI is something that you know, it’s a not a lot of people are experts in it for good reason. It’s kind of boring, like the whole goal of it is to not have to worry about anything. So because of that it even in the pension consulting community, the kind of like the lockdown assets, the like, Okay, we’ve allocated those over there once a quarter I just kind of ring you up and be like, is it doing what I thought it was doing? And 90 and 100 times is Yeah, it is. And everybody goes back to phones and and equities and PE and VC and so on and so forth. So it’s funny that the will call it locked down. Boring piece of the book finally showed up and headlines and and obviously you only show up and headlines and things are kind of hairy. It’s not because everything’s going really well. But ya know, it’s a fun one that I oddly have some direct experience and so from 2013 to 2016 that was at the UK asset manager Legal and General in the US arm But the group I joined was called the solutions group and their core offering was LDI. To us, mostly corporate pension, some insurance and Publix. But, you know, LDI really has a corporate pension game. And why that was interesting to me at the time was a large corporate pension that implements LDI strategies, they do so via separately managed accounts. And their holdings are a mixture of credit and treasuries. And as you say, as a derivatives guy, like, if I have a segregated account of a bunch of treasuries, that’s collateral, that’s a huge opportunity to build out a derivative overlay business, you already have the relationship, you already have the assets, you already have the collateral, you already have the correct operational structure, like, this is great. This is a easy tack on cross sale, business. And so that’s why I did that shift and my career for those three years. But yeah, from those, you know, great brains,


Jeff Malec  05:56

by the way, legal in general, right. Very, very, very UK.


Zed Francis  05:59

Like you can tell it’s insurance like,


Jeff Malec  06:02

right you like you work at legal in general, and then you go down after the day and have a pilot or in an engine or something. Right,


Zed Francis  06:09

exactly, exactly. But anyway, from from that three year experience, like know the ins and outs of LDI. A pretty darn well, both the US side and the you know, across the pond UK side from having a UK parent.


Jeff Malec  06:26

So correct me on my naive understanding here. So when I read the headlines, it’s like, Oh, right. They they’re trying to match their liabilities to their asset returns. Right. So I use the example they have a billion dollars in annual liabilities. So in gilts, English bonds are paying a yield of 1%. So if I want to get a billion dollars out of that a year, I need to buy 100 billion in gilts, right, that would throw off a billion in yield. And you can correct me after a second. So I was like, okay, but the problem is they don’t have $100 billion. So they borrowed or they levered up their portfolio via futures or whatever, to say, Okay, give me 100 billion exposure, to get the billion outflow, and then just got railroaded by the duration mismatch.


Zed Francis  07:15

So it doesn’t really have anything to do with, we’ll call it yield, or just, you know, cash distributions from other things, right? There’s no free lunch, like you use derivatives to, you know, buy a bunch of duration, on swap, there’s, there’s no income coming from that it’s a risk parameter, right. So it’s balancing the risk exposure of the assets and liabilities to match. Yes, the ultimate goal of LTI is to have your pot of assets, be able to pay for all the distributions that you have in the future. And that’s, you know, if you’re a pension, you know, basically what your distributions are going to be, if your actuary tell you like, this is how much we expect everybody to live. And this is the waterfall and hey, this is about what you’re gonna have to pay out every month going into, you know, perpetuity, if you’re an annuity, same thing, like we have a pot of money today. And we understand that we have to pay things out in the future, and we’re building an asset portfolio to best pay, you know, have the likelihood of paying out those liabilities I distribution, Same Same difference. You know, in general, insurance contracts are quite similar, you have a pot of money today, and using that pot of money to be able to pay off expected distributions, ie liabilities into the future. So, you know, very simply, that’s the goal is you got a pot of assets, and you hope those pot of assets are going to be able to pay off all those distributions into the future, the distributions into the future are pretty darn well known. Like they’re not shifting around a ton. Every once a while, you know, the actuaries say, oh, shoot, you know, people are living longer and your liabilities might go up. But you know, in general is pretty darn well known. So what’s different?


Jeff Malec  08:55

I’m gonna share my screen while you’re talking about this. Oh,


Zed Francis  08:59

right. So that that that right you’re blowing up is is, you know, the post era, which is just a very vanilla sample of what our cash outflows look like your liabilities are known distributions for a US plan. And that’s the key. That’s the US plan. And then the asset mix that you’re going to have that kind of best matches those cash flows, which again, is a blend of credit and treasuries. So really, you said like, it sounds pretty darn vanilla, pretty darn low risk.


Jeff Malec  09:28

But my immediate question is, isn’t this just what everyone’s doing? Alright, you’re trying to get an asset mix that pays your liabilities? Like where’s the moment


Zed Francis  09:37

that there’s there’s no super aha moment to be to be frank, most investors think an absolute return, like, like, Hey, I just want to like turn my pot of money in terms of the biggest pot of money possible. And if you’re an insurer, whether you’re running traditional insurance product annuity product or again, a pension, that having returns greater then the amount of money you have to pay out has very little benefit to you ultimately, right?


Jeff Malec  10:05

The rest of the charge a performance fee, you don’t get to keep it,


Zed Francis  10:09

right. And if you’re a pension, like, the money’s kind of trapped, like, it’s really hard these days, you know, back in the 90s, it was different, but like really hard these days regulatorily to get the money out. So, so if you if you’re a CFO, at a pension, you don’t really care about the health performance, you just want to make sure you don’t have to put more money in like, we’re just like, do I have enough money to go ahead and pay for all my liabilities into the future? And then again, that’s why you know, LBI is a subset of an in like, you know, financial services industry that you don’t come across with you don’t very few people, you talk to run pensions. And they’re the you know, those are the kind of folks that would actually care about this. So, right, like, this all sounds again, vanilla boring, like, how the heck could something possibly go go wrong? I wanted to like start off by saying the US and UK pensions are very different. So, you know, everybody’s saying like, Oh, shoot, what happened in the UK is it’s going to come to the US, it’s, it’s pretty darn unlikely, and it’s completely structural. So first off, the US starting, you know, a good 4050 years ago, started shifting retirement, corporate entities from DB defined benefit, ie pensions, to DC defined contribution, meaning 401 case, right. So that’s shifting the liability from the corporation to the individual, right now, the individual is responsible for their own retirement. Sure, they’re, you know, adding additional money to the 401k, you know, matching contributions. But it removes the liability from the court Corporation, it shifts at all to the individual. In the UK, it’s not the case. And basically, legally, you can’t do it, they’re still all defined benefit plans, ie pensions. So one, the market in the UK is substantially bigger than it is in the US, just because in the US we’ve had, you know, 4050 years of runoff. So it’s smaller, my corporate pension in the US are only like $2 trillion, which seems like a big number. But in the US with 200 Plus trillion of assets, which include housing, and all that kind of thing is this, then it’s not very big. Thanks. So it’s hard for it to create a massive influence on the marketplace, we’re in the UK. That’s that’s not the case, it is a substantial portion of the overall market and a substantial portion of this specific market, which we’ll get into as we keep wandering on the path. The second bit of that is if the US pension universe has slowly been shifting from DB plans to DC plans, it means it’s all legacy liabilities, you’re all like corporations are paying, you know, pension distributions to 5060 year olds, they’re not accumulating new ones from like, the 2030 year old is just starting to work. We’re in the UK, that’s the opposite. They’re still collecting new liabilities from the person that just graduated from university is entering the workforce. This means the duration of the liabilities in the UK is substantially longer than the duration of the US. Because again, we’re just legacy, you know, distributions for the most part, where that’s an ongoing plan. And so that what that’s called the pension world is closed plan. A, there’s no new participants entering the pension plan, versus an open plan, meaning there’s new people showing up every day. And so of course, if you have a bunch of 20 year olds, it means your long dated liabilities are still pretty hefty. We’re here, it’s just Oh, like the actuarial chance that a bunch of people live to 110. Right? It’s small. So you have the mismatch of okay, it’s a really, really big part of the overall investing universe in the UK. And just the liabilities are like 50% longer comparison in the US simply because the plans are open versus closed. And then the final piece of that is well, okay, one more, one more big difference, while we’re big difference between the US and UK is the discount rate. So we all think of you know, we’ll call it equity world DCF model, like, you know, that’s just discounting all those future cash flows to get to a present value today. That’s all that’s going on in LDI as well it is discounting all of those future liabilities, those cash flows those distributions to a value today, same math, you know, very, you know, boring for for the most part, the only difference is what the heck are you using to discount those cash flow. So, you know, equity world might say, hey, you know, I gotta earn treasuries plus 4% For me to buy that equity. So, you know, today, whatever, I’m just gonna use an 8% discount rate for my equity cash flows. For us, and UK pensions. It is different Mine is regulatorily defined on the corporate pension side, public pension is way different in the US. But on the corporate pension side it is defined and in the US, those liabilities are discounted by extremely high grade credit, I A are better, you know, single a double a triple A credit, whatever the yield is across the curve on that credit. That’s how you’re discounting those liabilities to today value. And thus an infinite affects how you’re gonna invest, if you’re just gonna raise credit, you’re gonna buy some credit, the theory


Jeff Malec  15:32

being you can write, if they invested just in that index for that asset class, they would get that return and they’d be


Zed Francis  15:39

like, I’m discounting it based on this asset. And as if I buy that asset, it’s gonna give me that return. We’re all done, right? In the UK, there’s not really like depth credit market. And what they utilize is their discount rate is a mixture of gilts and linkers. So gills are just treasuries, and linkers are essentially tips. So their discount rate involves length they treasure the new one. Yeah, treasuries plus inflation like that, that is the mix of how they discount their liabilities over there. So rather than you know, owning a lot of credit, they own gilts and linkers, ie treasuries, and essentially, tips. So those are kind of like your major differences UK much bigger, you know, part of the overall market their liabilities a lot longer, because our plans are open, I knew folks are getting a pension versus that’s not the case in us. And then finally, the discount mechanism in the UK is essentially treasuries and tips I inflation vehicle called gilts and linkers. For the US it’s credit. So those are major differences between those two universes.


Jeff Malec  16:56

Right away, I see the issue there, right, that guilt, volume and liquidity is way smaller than US Treasuries, even though the UK pension system that relies on that is much larger. So there’s a mismatch there. Right?


Zed Francis  17:09

So well, like we’ll start waterfowling into like, Where does the risk show up from this situation. And so, all right, if your plan in the UK is still open, that means you have known future liabilities, but also unknown future liabilities, I every time you hire a new employee up, we got more, right, like we’re continuously potentially adding. And if you’re CFO of corporate, and your plan is 100% funded i You have enough assets to go ahead and support all those future liabilities, which is incredibly common in the UK, actually. And the reason for it is actually LDI, that was a successful thing that they were doing LDI prior to 2008. And so they didn’t have the US problem of being, you know, 110% funded. And then 60%, funded after the great financial crisis UK actually was 100% Fun in pretty much all that time. So you’re 100% funded, but you know, your liabilities are gonna go up, if you continue to hire people, which is a corporation, you’d expect that to actually happen. So if you’re a CFO, one of those plans, you don’t totally lock it down, you locked down like a big percentage of it, and you know, LDI to try to just pare things off. But you also want to take a little bit of risk, and you want to earn those liabilities a little bit. Because that way your pot of money can also achieve enough returns to pay for the new people versus taking money out of earnings to start, you know, put funding attention to payrolls, do people so


Jeff Malec  18:43

why wouldn’t I just put new LDI instruments on as the new people get hired,


Zed Francis  18:49

because the more money you have to fund it, you have to go actually take money out of earnings, that damn running and actually pay for this person. So you want a little bit of like, whatever having your cake and eat it too, I want to de risk it. But I also want to take a little risk to you know, the 5% of new people I hire every year that the pot of money already have can go ahead and support those folks. And so over the last you know, 13 ish years when the Treasury and or gilts market and the tips and or linkers market was very, very stable. It was kind of a an appetizer to go ahead and start taking a little bit more risk and a little bit more risk is a rather than buying gilts let’s buy like some oddball stuff that are basically government protected. So like in the US, it’s like, you know, they’re Brady bonds, ref COEs, things that are technically backed by the US government, but are a little different. And so they have a little bit higher yield. So like, you know, people in the UK where rather than buying gilts starting to buy some of that, you know, little bit riskier stuff to get an extra 20 basis points because that’s the kind All they need, they need just a little bit to, you know, outer in their liabilities to pay for the new folks. And then, you know, nothing continued to happen. So what do you do you go out the risk curve a little further, and they start buying, like truly illiquid stuff like private investments that have, you know, one month case, you know, like not not, you know, crazy, like private credit funds or whatever. Yeah, right.


Jeff Malec  20:23

So it’s like, I have access to the capital. But this is where it separates from just an LDI story, right? So it’s like, that’s the base of what’s going on. But then what you’re saying now is what I didn’t understand of this isn’t that LDI enabled this leverage in more risk taking? Or depends, I guess, what side of the coin, you look at it, but you’re saying, Okay,


Zed Francis  20:43

your your your secondary pot of collateral, if you will, they start in, you know, going out the risk curve and illiquidity curve a little bit to try to find that extra 20 3050 basis points, you know, per annum. And so your secondary pot of liquidity is obviously getting more illiquid. And thus, if there’s giant moves, it’s becomes problematic, because your access to that liquidity for collateral needs is diminishing, as you keep going out that risk and liquidity curve. So that was definitely happening over there. One of the biggest separators though, I would say, you know, this all falls under we’ll call, you know, effective risk management. So, there’s definitely folks out there that had no problems because they didn’t allow their clients to do this. They said, You know, we’re, we actually think it’s plausible in our model that a 200 basis point sell off in a month is possible, and we got to make sure we have enough collateral to be able to handle that. And when their clients said, Well, can I do this? And they said, No, and maybe they went to a different manager that allowed them to do it. Yeah. But one of the biggest issues is the


Jeff Malec  21:57

let me pause real quick. So what does that look like in terms of leverage? If I’m like, Cool, I want to put on this and this and this, like, how much? We’ll go back to my example of the a billion dollars they had, how much of that? Nominal are they at 2 billion? Are they at 3 billion or that one?


Zed Francis  22:13

Let’s let’s talk about in duration terms, because that’s easier to like, comprehend. So


Jeff Malec  22:19

apologies if you’re already gonna get there and I.


Zed Francis  22:22

So you know, if you’re buying cash only instruments, like I 30 year treasuries, 30 year gilts, the longest duration, you can kind of get to and gilts because they don’t really strip things out with liquidity, like you could buy a 30 year strips here, which basically have a 30 year duration, which is like zero coupon bond where you put money in today, and then you just get money back in 30 years. And because you get back in 30 years, and basically as close with 30, or duration. If you have like a 30 year treasury, you obviously have a bunch of coupon payments, and then you get in theory, your 100 bucks back. And because of that the duration of your 30 year Treasury at these rates is at like low, low 20s. At this point, similar to gilts so Okay, so the most you can get from cash investments is kind of like low 20 duration. The problem is you have really, really long dated liabilities. And not all your assets are in fixed income, you got a little bit equities, you got a little bit of credit, that shorter duration, you want a little bit of you know, private investments that are shorter duration, so then your LTI portfolio just has to make up for all the duration that those assets don’t have. So you can push your LTI portfolio to have a duration of 3040 50 years. And, you know, I would say most risk managers would probably try to cap things at about 14 ish years. But, again, we’ve had 13 years of pretty stable interest rates globally. And when that happens for a long time, you know, sometimes the we’ll call it the, the asset raising sales team can convince good risk managers to take on a little bit more than they necessarily wanted to. So that’s your starting places, you know, let’s say like an LTI portfolio in the US, on average, probably has like, a 30 year duration, I even be a little long, but 30 years duration. And like in the UK, it was like a 40 ish, your duration, something along those lines. But obviously, when rates start selling off, which they have, you know, prior to the last two weeks, you know, started the year to, you know, a month ago, they’ve already sold off substantially, that that means the duration of your portfolio is extending simply because you are trying to maintain the same amount of exposure, but your asset base is falling because you have some leverage within there. And so your duration slowly but surely extending. But if you’re a good risk manager, you would have had many, many many, you know, conversation hard conversations with clients to say you need to give me more capital well before two weeks ago


Jeff Malec  24:55

saying that they’re edified by a million dollars in 30 year bonds If I’m in year 29, right, like, I’m pretty darn sure I’m getting my million dollars back my principal back ignoring the coupons, in year three, and I’m down to 800k. In that, like, that’s pushed my duration out that hole, right 27 more years, in order for my view of, of when I’m gonna get that that principle, but yeah, but I think, by definition, the duration is actually the same, but it’s like the, the psychological view of what it is right? As soon


Zed Francis  25:29

as you started using, like in the UK, they’re using swaps in the US are using swaps and futures, like each firm, does it use a different tool,


Jeff Malec  25:38

technically, actually adding more duration vs, they’re


Zed Francis  25:41

adding more iterations to those LTI portfolios for the same amount of capital that you have. And the capital is also going to be invested in gilts and over treasuries in either place. So as you start losing money, you’re trying to maintain the same amount of exposure, because again, the exposure you have is just paired off with your future cash flows, like the goal is just to hold on for 50 years, if I buy these things, and I, I’ll be able to pay out everything, but I gotta be able to hold on to everything for the whole, you know, 50 years. As the market started selling off, rates are going higher, that just means the duration of portfolios naturally extending because your capital base is falling, even though the exposure that you’re trying to hold, it remains the same. And so, you know, at March, you probably had to call clients as a hey, I need you to contribute, you know, a little bit more money in June, you probably said the same thing, like as a good risk manager. And then yes, the last two weeks were chaotic. And you probably were calling for more money, but it wasn’t the like margin call, I need more money tomorrow. It is, hey, guys, I need more money. We’re still fine right now. But like, I don’t need it tomorrow, where things got hairy, most likely, but pretty confidently, is larger pensions, we’ll do everything in separately managed accounts, you get a lot of benefits for from that. And the manager gets a lot of benefits for that. So if you are running an LTI portfolio, and then SMA separately managed account, then it’s pretty easy to go ahead and recapitalize that portfolio. Because you’re talking to one person, it’s their account. And when you say Hey, guys, do you have some cash? Do you have some credit? Do you have some equities? We need, we need some more collateral, it’s pretty easy for them to say yep, we’ll go ahead and move it from Padang to part B, you’re now collateralized. Not a big deal, or at least much easier. In terms of the situation, where you have issues is in commingled products, whether it’s you know, us like CIT, or a fund or anything along those lines, whereas a bunch of investors and a single product, because if you have leverage and a commingle vehicle and you start, you know, getting a little bit more risk and a little bit more risk and a little bit more risk. It’s kind of out all the things you can do, like, are you gonna call 100 people and say, Hey, we’re gonna give you your money back if you don’t give us more money by the end of the week. That’s not really


Jeff Malec  28:08

they might say, yeah, perfect, right, that’s


Zed Francis  28:11

not really a successful process and a combing over you. And in the UK, again, because it’s essentially mandatory for any sort of corporation to have a pension plan. That also means there’s a lot of small pension plans, you know, a lot of 500 105,000 employee type places also have pension plans. And so you’re talking about 20 million pound pots of money that the the manager probably doesn’t want to do an SMA for. So, hey, we got, you know, billions and billions of potential assets, but they’re all in $20 million increments. What are you gonna do? Well, hey, we know how to do this, all the things, let’s just make it fun. And we can have multiple different funds, we could have like the low duration fund, the medium duration fund, the hydration fund, the leveraged high duration fund, and we can go ahead and basically do bespoke LDI for you by just having different allocations to all these funds. But ultimately, it’s probably not the right vehicle to be doing something that involves leverage, because it’s really difficult to recapitalize that vehicle and that is likely where the stress really came from two weeks ago, is those funds that had derivatives in them to extend the duration you know, to you know, 4050 years started going to 60 7080 100 years on the aggressive sell off and gilts ie treasuries just UK style and along with it, you know, swaps are they’re cleared like they are here now, but like, you know, this is a this is an exchange, you know, margin coin. This isn’t you having an OTC instrument with like a bank where you can buy Get some flexibility, you know, you as you know, well, you know, Jeff, like when the Exchange says give me more money, you’re on the shot clock, you don’t have a lot of time to go ahead and solve this situation. And so ultimately, like what really caused a waterfall event in the UK is one really big part of the market, like overall market one, two, their durations really, really long because the plans are open, you know, three, like, everybody has a pension like it’s basically mandated, which creates a bunch of smaller pensions. And then finally, like the asset managers say, hey, like, we need to be able to service everybody. And we don’t really want to do teeny, tiny SM A’s. So like, let’s create a vehicle that’s easier to accumulate a bunch of these assets. And that commingle vehicle was probably the ultimate downfall. There’s a bunch of, you know, steps to get there. But like, that’s, that’s where the problems really arose, along with obviously, then jamming, like we’ll call it more illiquid assets and all these things to reach for additional yield, obviously problematic. But the biggest issue was basically having, you know, a decent amount of these assets and funds rather than SMA vehicle, because there’s there was, there was no release valve, right, you know, you’re just marching. And so


Jeff Malec  31:15

those funds had to go in and sell gilts basically.


Zed Francis  31:19

Right. So they were forced to liquidate. And, you know, I actually are synthetically Yeah, and so, you know, I’m not picking any managers, so I’m not going to


Jeff Malec  31:29

get the managers like banks were in talking in the UK, there’s


Zed Francis  31:33

three, like there’s, you know, smaller ones and stuff, but there’s three predominant, it’s legal in general, it’s insight. And it’s BlackRock, like, those are the three majors like, and they basically own the market in the UK, and why


Jeff Malec  31:47

do they need is a manager needed? It seems like it’s what used to be simple enough where you could do it in house, but I get it for the small,


Zed Francis  31:55

I mean, like, again, a lot of people don’t really love doing bond rat math and key rate durations and maintaining, like a trading desk and and ultimately, Jeff, like, they’re not, they’re not charging substantial fees, like I’m talking like, they’re charging three basis points, like big, big pots of money, and those, like funds that are smaller pools, probably charging, like 15 basis points. So like outsourcing, this doesn’t make sense, like, for folks, but your largest asset manager in the world, sent out a piece last week that basically, you know, patting themselves on the back, saying, you know, what is all this LDI and like, we’re great at it. Like it was kind of a champion piece, as part of it. And again, like, yeah, oh, yeah, like, we problem solve kind of like these. And as part of that piece, again, I’m like, kinda like, the context around, it was like, you know, we’re good at our jobs, you know, would say something different, I think, to our minds, and the exact words for this segment was, we’ve been reducing leverage in some of our LDI funds, acting prudently to preserve our clients capital and extraordinary market conditions. So that’s, you know, the fluff of, we, we really levered, like we, and we did so like, maybe not the best time and my we’re kind of forced to do it. Now we can, you know, sugarcoat it and say, like to preserve our client assets. But again, your clients hired you to own assets to match their liabilities, which you were doing. So taking off any exposure is not exactly doing your job. But that is a forced decision that is not good for your client. And again, they give you a little hint, LDI funds, they specifically said their funds rather than all the I, again, signaling where the event likely took place.


Jeff Malec  34:11

Do you feel like this is a problem? Right? Some bent on who I like, but it gets a little conspiratorial at times, right? He’s like, this proves financialization is run amok and right, like all this stuff of like, it went too far. And it got sold by these groups of like, you need this, you need this, let’s add more leverage, right? Was it a money grab of them to kind of that I know, you don’t know all the answers, but just your thoughts on?


Zed Francis  34:35

Yeah, so I would say there’s to be that. So, you know, leverage is a is a interesting term within this context, right? Because, again, like these weren’t absolute return bets of any variety. It is like, I have to make all these payments in the future. And I’m building a portfolio that pairs them off, but the key is again, you gotta be able to leave the both sides in a drawer, like you can’t have anything happen, like in the middle. So it’s like, you know, essentially like a convergence tray. Now, obviously, like, the most famous trade is a disaster with long term capital management. But again, that was like, you know, in our position with a ton of leverage where this is ultimately like, you know, I got a bunch of money to pay in the future, I need to buy assets that pair those off. And if there’s decent risk management, the correct operational structure, like, it’s, it’s, you know, never say never, but like, it’s very unlikely, disastrous things happen. Now, when you stop, you know, focusing on good risk management and more on absolute return, or possibly, you know, increase sales, and put things in, you know, a less, you know, efficient operational structure, or be able to access additional collateral for something that involves derivative derivatives. Yeah, like problems can show up. So, you know, leverage is, like, an interesting word where you’re like, you know, I’m trying to like, I have one over here, and I’m trying to have one over here. And yes, I need derivatives to make that happen. There’s, there’s, it’s not taking leverage in a, I’m making a bet type of scenario, but you do need to have a risk management and good operational structure to do things correctly. On the other side of it, you know, without a doubt, what took place before, you know, the Bank of England showed up, is all these folks basically said, Listen, we need more collateral before the market opens tomorrow, or else the pensioners are going to be left holding the bag. So they came in with a compelling pitch, to central bank to have the Safe Money, like common person, all the UK citizens are gonna be left holding the bag. And we don’t, we don’t actually care where the market goes, ultimately, we just need to convert the liquid stuff into liquid stuff to be able to post we got to draw close, we need a bridge, right? We need a bridge to be able to keep the door close. And so you know, the Bank of England responded. And as you’ve seen, like, every single day, you know, whatever their number was that they’re willing to buy every single day, they’ve been only buying like, tempers on that right? It’s the facility they created hasn’t really been used


Jeff Malec  37:36

after the headline, then the amount of ammo Right,


Zed Francis  37:39

right. So we like most likely the funds were forced to de risk, they don’t have a choice to find more collateral. So they’re there already went from, you know, at that point, probably 80 years duration back to 40. So they’re stabilized. The SMA accounts had the little bit of time they needed if they even needed it, to go ahead and re collateralize themselves. So you know, the Bank of England will say, for a moment Job well done, I guess. Minimally statewide sings a pen Sharia


Jeff Malec  38:15

English slang.


Zed Francis  38:17

Yeah, but what’s what’s, as you mentioned, at the start, like were all the way back, essentially, to those same level of yields. And in my view,


Jeff Malec  38:27

which caused more collateral needs, right,


Zed Francis  38:30

it is a completely different story now. Okay. So initial catalyst, yes, likely pension driven mainly from the commingled funds associated with LDI in the pension world. Now, I think this is the, you know, we’ll call it ultimate fear of all central banks, kind of like move, which is, you know, for over a decade, it was, you know, don’t fight the Fed, don’t fight central banks. And the last week and a half might say, oh, man, maybe maybe it’s actually finally profitable to fight. These, you know, central bank policies, I maybe the market finally has some control of fair market value, rather than, you know, any sort of manipulative, fair market value that central bank policies can can kind of drive. So I think this is very different. I think this is we’ll call it natural sellers making bets versus any sort of forced liquidation from the pension plan community for this second move here. Which I also think is why, you know, our fed mic microphone pieces have been out every day for the last couple of weeks, because I think they kind of realized this is a credibility problem. Whenever we we lose credibility, that means we lose control. And if we don’t have control, you know, thing we don’t we can’t stop things if they actually get bad.


Jeff Malec  40:09

Well, yeah, it was kind of right. It was, hey, we’re tightening and going to do these purchases at the same time. It’s like what? Bank? Thanks. So that’s what you’re saying like that they lost credibility, saying they can do both those things at the same time.


Zed Francis  40:23

And the the initial actor, if you will, is likely been mostly cleansed. And now it’s now it’s more a marketplace saying, wait a second, like, maybe, you know, yields should actually just be higher.


Jeff Malec  40:36

Yeah. And maybe, maybe that long term cause cures this right. Like, that’s to me, would all this have happened if we weren’t didn’t go down to zero rates, right? Was the extending duration, all that just because we’re at such low rates?


Zed Francis  40:51

It mean, it’s a huge driver of just natural duration extension, right, like a 30 year bond at a 10% yield versus a 30 year bond and a 0%. Yield? Has 2x the duration just naturally same bond when yields zero? So it’s a just natural, massive duration extension by having really low discount rates?


Jeff Malec  41:12

And is it fair and coming back to volatility and options talk, like, kind of duration equals volatility in that scenario, right.


Zed Francis  41:20

I always think it’s funny. Like, I feel like this is why a lot of basically non fixed income people, duration is hard to grasp. What I mean by that raising my hand.


Jeff Malec  41:34

Like, don’t tell anyone that I started my career in the bond pit and I don’t really understand duration. But yeah, I mean, like,


Zed Francis  41:40

I think I think the simple reason for that is, if you’re an equity investor, longer timeframe, is viewed as less risky, right? Like if I have a 30 year holding period, like there’s almost no risk to equities, and we have a 10 year holding period, like more risk, but still nothing. And if you said like, one day, you’re like, Oh, my God, that’s a ton of risk, right? In fixed income is literally the exact opposite. Like a one year, one day bond has essentially zero risk, like, you’re gonna have default, like the next 24 hours, you probably know about that, that’s gonna happen. Yeah, versus 30 years, like a heck of a lot of things can happen. So I just think the most people are absolute return space, meaning, you know, equities VCP you know, real estate, we’re time is your friend, like time means less risk. We’re in fixed income, it’s obviously the exact opposite, the more time you got, the more risk you have.


Jeff Malec  42:32

But that’s confusing that 30 year bond 10% 0% has the same technically as the same time period to it,


Zed Francis  42:39

Iberian, so, right, but the the, the the known, like, fixing him, you have a known amount of the best case scenario, right? Best case scenario is to get all your coupons and your money back. Like, you can’t do better than that, like you have to mark to market. Better than that over a 30 year period. But like, that’s the best you can possibly get, we’re obviously most other assets you’re hoping for upside beyond a known situation. So that I mean, that’s why it creates a situation because, you know, the best possible seat and only bad things can happen in comparison to that seat. And if you have a 0% coupon, like, there’s not a lot of great things gonna happen, I give you money, and I get it back in 30 years, right? There’s all we say, give 10% coupons every year for 30 years, and then give my money back. So it’s a less risky proposition of higher yields.


Jeff Malec  43:31

Right. So I guess you’re another way of saying on the on that 10% You’re gonna get some portion of those coupons before something bad happened, which in effect lowers that duration on the zero? There’s, there’s none of that. So.


Zed Francis  43:44

Yeah, right. That’s where your Austrian like 100 year bond, whatever it was, like 1% was pretty darn scary.


Jeff Malec  43:52

One of those countries had 100 year bond and ceased to be a country. Oops, however, there’s


Zed Francis  43:57

been many, I mean, Ford issued hundreds, and also went through restructuring.


Jeff Malec  44:08

I’m still a little confused on where did the derivatives come in. So I’ve got my LDI I’ve got that that’s all this I want a little extra return. So I’m gonna I started doing private credit. So again, it’s


Zed Francis  44:19

less return, and it’s just matching the duration of your liability. So again, like, you know, we’ll try to use round numbers. So say, you know, say you got 100 million of assets today, and 100 million, discounted today’s dollars of liabilities. So we’re like, Okay, I’m one for one. I want to like, just be done. Make those assets look exactly like those liabilities. And if you’re a UK pension, just to make, you know, numbers, we’ll call it simple. Say that 100 million in liabilities had a very, very long duration. It had 30 years. Have duration and your assets if I just wanted to invest in gilts a treasuries just cash investments, the most I can get to for simplicity’s sake is 20 years. So I got I got a 10 year duration mismatch. So how do I fill that hole, I’m going to go ahead and buy swaps. And I’m going to buy enough swaps to get the duration of my assets to also 30 years. So now, you know, my assets have a 30 year duration, my liabilities have a 30 year duration and my assets get get their two thirds, you know, cash investments and gilts and 1/3 via swap. So that’s where the Drake, like, you know, the the derivatives come into play is just hey, the liabilities are just really, really, really long duration. So I need to add more duration to my assets. And who’s on the other side of the swamp the banks. Yeah, so that Okay, so that’s another one. That’s interesting, what we’ll call it UK versus us. So in the US, like many, many, many, many market participants are trading those swaps right now, whether it’s macro hedge funds, or veterans or insurance or the banks, like, there’s a bunch of books. For the we’re talking specifically the long end. So like in writing, Sammy


Jeff Malec  46:10

came out with like ultra futures and tried to extend those and offset their exposure on the swaps they


Zed Francis  46:16

sold, right. So in the UK, it’s even, it’s even longer. So like the US things get capped out at 30 years, at least for the moment, Minuchin tried to get the 50 year And amazingly, Congress didn’t like that, for some weird reason. Seemed would have seemed pretty good to issue a bunch of 50 year paper back in the summer, 2020 today. But without that sidebar, the UK, because they had very long duration liabilities, they did the same thing, as you know, you’re saying this email creating the Ultra, they created a 50 year slump, because they needed longer duration, like how do we do this, okay, the best way to do this is create a derivative that is even longer duration. And that’s the fifth year swap in the UK. Now, these are just, you know, we’ll call estimates from chatting with friends over in that space. But last I caught up asked for the estimate of like, okay, long term gilts like the longest cash instruments, and then the, like 50 year swap, like, who actually is long those I you know, receiving coupons versus paying coupons, long duration, and those instruments, and they’re saying our pension communities about 50% of the 30 year, gilts is you know, who owns them. And then about 9090 plus percent of the 50 are swapped. Right? So you have basically one place owning all of it. Yeah. Which is obviously not a great seat when everybody is having unwind. Right. And the who’s taking the other side of it is banks, like, they’re just playing the curve trade, like, they’ll go ahead and you know, quote, unquote, sell them, you know, pay on the 50, or swap, and then they’re gonna buy, you know, 2030 year swaps, and they’ll accept the curve risk associated with it, because they obviously think they’re going to make enough money on the spread, to go ahead and facilitate that. So the banks are definitely facilitating and hedging themselves. They’re not just naturally on the other side. But yeah, I mean, the UK pensions were very one sided in that market.


Jeff Malec  48:23

So does this all fixed? Now that all go away? Or there’s still a problem? Or what can they do to plug the hole? So those small funds seems like one or


Zed Francis  48:34

am so the problem is, you know, it’s, it’s kind of the responsible thing to do if you’re a fully funded pension plan, is to try to best match your liabilities, so then you’re more likely to be able to pay them in the future, right? Like, you know, the US corporate pension system is disaster in comparison, the UK pension system, only because we adopted LDI, you know, in the last seven, eight years versus 15 years ago, ie corporate pension, still haven’t fully recovered from the great financial crisis, there’s still a bunch of pensions that are 60 70% funded, which, which ultimately becomes, you know, liabilities on all of us citizens. Like in the US, it’s called the PBGC PBGC, which is essentially the the federal backstop for all corporate pensions, like everything, it becomes all of our


Jeff Malec  49:29

liability. You and I Chicago taxpayers, right on that Chicago real estate tax bill, and it shows you’re probably


Zed Francis  49:36

a different question, but yeah, 42,000 in


Jeff Malec  49:39

firefighter pension and 24,000. And


Zed Francis  49:43

so yeah, I mean, like, ultimately, I will some regulation come in.


Jeff Malec  49:49

Right. Your action would be don’t let these pensions do derivatives. And you’d think that’d be a mistake, right? Like,


Zed Francis  49:55

yeah, I think it’d be a mistake. And I think I you know, I think the lobbyists out there will be able to fight that what they might be able to do is say that yeah, and you can do anything you want in your own account. But if it’s a fun, like you can’t take either either no derivatives, or you can’t take duration over some random number, like, I wouldn’t not be overly surprised if you know when the dust settles in two years, that they do do something to the funds, because they’ll, at that point in time, they’ll be able to go through all the wreckage and say, like, oh, geez, like, something very specific was the problem. It wasn’t like, the whole space.


Jeff Malec  50:32

And then it’s interesting too. That’d be right. Did one of those funds just put in like a billion dollar guilt sale that like the market can end on if they did, like simply iceberg dead or something over a week or something? Right? Who knows what


Zed Francis  50:46

again, you’re they were getting probably margin call, like, actually margin call by the exchange. So they were like, they probably were, you know, doing the like, oh, shoot, like, our risk parameters, say, if a x basis point move and guilts causes to run out of cash, like, you got to start liquidating stuff now, like that probably happened, you know, the week and a half leading into, and then helped us get to where we did


Jeff Malec  51:13

so so that the end of the day, it’s not derivatives or bad leverage is bad is just some risk mismanagement in your opinion.


Zed Francis  51:21

Yeah, it’s poor risk management and poor operational structure, which is, you know, nine, nine out of 10 times the issue with everything. You put yourself in the wrong structure, you have no liquidity, and you did some not fantastic risk management, like you got yourself into trouble.


Jeff Malec  51:37

And then so you just mentioned, it was like an equivalent on


Zed Francis  51:41

our side would be like, we’ll bring it back to equity vault space. There’s all those like VIX, ETFs, right? Like, that requires a lever leveraged in a commingle vehicle. Now, if you were able to like, risk managed short, the VIX and were able to re collateralize things during hairy times. Like you wouldn’t have blown up. 2018 But because you know, you were doing things, one for one, like if you if you were just like, each unit was only short, you know, 20% of a vix future. And or, like there was a mechanism to re collateralize it like, you would you would have made money for


Jeff Malec  52:22

the ETF switch to 20%.


Zed Francis  52:24

Right? That’s right. No, like, people wake up and say, oh, shoot, like, let’s, let’s pull up a different way in the future.


Jeff Malec  52:31

You mentioned so us have added this in the last seven, eight years. So that I think that’s where people are grasping out of like, this is a problem in the US. This is coming for us too.


Zed Francis  52:42

It’s just structurally it’s different. Right? We’re us pension plans aren’t big enough. In terms of like, everything that we we have in terms of assets, they just don’t


Jeff Malec  52:52

go into our treasury market. Not big and right. Yeah, I


Zed Francis  52:55

mean, like it. One, US corporate pensions aren’t big enough to like, do much moving assets like period. Next, our liabilities are just way shorter. Like you know, because they’re close plans, like, we don’t have 100 year duration, things like we don’t need it like or liabilities are just way, way, way shorter. And like a funny thing is because US corporate pension plans are less well funded. Because we’re underfunded. corporate venture plans aren’t a bunch of equities, the automotive PE they own a bunch of 100% LDI. Because they they still have ground, no makeup, like the they can’t go well, the full LDI until they’re you know, 100% funded. So it’s just a totally different landscape in the US in comparison to UK.


Jeff Malec  53:40

There were a couple articles I read were like, Oh, this is how pensions got out of the hole they’ve been in. And this is why you see so many doing so much better now. So that seems like that’s yes, that’s true, but not in a nefarious way. Just they started to manage it a little bit better. No,


Zed Francis  53:55

you I mean, us pensions want rates higher. Yeah, like that increases their discount rate, meaning lowers their liability, like the best, like the highest funding status for like US corporate pension since 2008. was March 2020. Because equity was we’re only down I’m sorry, 29, march 2020, march 2022 this year. And the reason for that is equities were only down whatever like 6% from all time highs, and treasuries, so left crapload like so their their discount rate was 100 basis points higher that was we were meaningful to improve their funding status than you know, how much equity is and fall and that was immaterial.


Jeff Malec  54:39

And last Pisa, Orange County SNL crisis similarities, I don’t know how much you know about those or what


Zed Francis  54:46

No, I mean, that’s just swapping, you know, fixed payments for flooding payments into fixed payments. And again, like Yeah, it’s a collateral issue. And the problem is they didn’t reserve any collateral. They just spent all the money, right. So I was like, you know, there’s always there’s there’s, you know, similar. If they could have just put things in a drawer for 10 years, you never want to hurt about it. But they spent all the collateral, you know, doing municipality things. There was there was nothing to recapitalize the collateral pool.


Jeff Malec  55:17

And then in options fake, is it kind of like these guys are short, a bunch of gamma? That’d be fair to say, they,


Zed Francis  55:24

you know, it they are and in their short gamma for actually a completely different reason. Like you’re really thinking it has an as to effectively do with the duration mismatch of the liabilities and the physical assets, which I would you know, that’s a fun whiteboard next. But yes, they are short gamma just in a different way than


Jeff Malec  55:48

a bar napkin exercise. It’s not whiteboard exercise, but sketch that on a bar napkin next step. Your strategy, one of the best performing past performance is not necessarily indicative of future results. volatility strategies this year, so without giving away all the secret sauce, tell us why certain vol strategies have struggled this year. Right? The classic every one the fix is broken and the markets down. Right down 25%. And the VIX hasn’t spiked, it’s been staying at 30. So basically give us a quick overview of how you’ve approached that and why it’s done. Okay.


Zed Francis  56:33

Yeah, I mean, any most folks in the volatility space are negatively correlated, ie, they want to make a bunch of money when the market goes down, that’s not you know, like, a relative value strategy. It’s a specific intent. They tend to look for expansion in volatility, I, you know, they didn’t vote to explode. And that’s the windfall event, how we approach things is, essentially, we’re long gamma. And what that basically means is our portfolio as the market goes down gets shorter and shorter and shorter, when the market goes up, gets less short, less short, less short, and then we rebounds you know, at some point in there, when like, Hey, we’re, we’re way too short, let’s go ahead and rebalance things and get ourselves back kind of in line, vice versa, market ripping, hey, we’re maybe not short anymore, the marker, if so much, like, we gotta go rebalance things to get ourselves back into the car. So it’s a, it’s a very, very different mechanism of how we’re trying to deliver our p&l. And like, you know, the, you know, look a geeky term would be we’re long convexity with respect to spot ie movement in the market. And most other folks are long convexity, with respect to Vega are vol, ie, they need volatility to move. So it’s like, a completely different fulcrum, we just need the mark, we want the s&p 500 to move a lot, and most other folks actually need volatility to to move. And this year, you know, has been a pretty big divergence in those two things. But ultimately, that’s kind of been the case ever since 2008. Like, there hasn’t been a lot of events where volatility is expanded greatly, other than, like, a two and a half week period and march 2022 and


Jeff Malec  58:18

a half hour period in February of 18.


Zed Francis  58:20

Right, exactly. And, you know, not to belabor it, but like, that’s kind of our expectation is in the first leg or so down, that volatility doesn’t expand might even contract. Because of a lot of, you know, products that are out in the marketplace that actually would become bigger sellers on you know, a 10 15% move. Certainly, if there’s a dramatic second leg where a 15% move turns into a 30 40% move, all the you know, all those products don’t matter. Like they’re not influencing the market anymore, like volatility is a lot of explode.


Jeff Malec  58:58

But those products are like a volatility based funds or like a JP Morgan hedged equity, something like that, that’s trying to that one’s not a good example. But there’s, there’s a lot of things or notes or, yeah, there’s a lot of things in the structure of product space.


Zed Francis  59:13

That cause like that kind of situation essentially when when, you know, the strikes are way way way out of the money. How the banks would hedge that risk is Vega, they’re not going to use a Delta driven instrument, they’re gonna use Vega but like as they become close to the money like they start using delta hedging instrument rather than Vega meaning like they’re shifting how they hedge meaning you know, they’re actually selling Vega so it’s a bunch of that stuff. And then yeah, like you know, your buffer now things and your hedge equity products and you know, your, you know, beauty related products also, likely, actually sell volatility on the first kind of legs down. But again, like When you get to like full online mode, then you know, that’s different than bought somebody’s really, really allowed to expand at that point in time. But, you know, our expectation and what we’ve seen for the last, you know, whatever, almost 14 years now, is actually when the market moves first leg down until you get to like, true illiquidity panic, that volatility is benign and even sometimes contracts.


Jeff Malec  1:00:22

And so that’s not saying that realize ball isn’t catching up to implied vol. You’re saying realize price movement, actual price movement, nothing to do with the bone. So there’s two, two pieces of it I write everyone else is complaining of like, realize never catches up to implied implied stays high and the realize isn’t doing anything. So is that a piece of that puzzle? And it’s different in European?


Zed Francis  1:00:48

It’s a piece of the puzzle. I mean, realize obviously picks up implies we’ll do a little bit of a catch up, like grasses, like, you know, the old, like if there’s, you know, really attractive money laying around, especially something that’s possibly convex people, you know, find it pretty quickly. But yeah, I mean, like, ultimately, the realized volatility year to date has been decent, but isn’t enough to kind of push implies dramatically higher on media options, a longer dated option. Sure. On weekly stuff, like of course,


Jeff Malec  1:01:21

yeah, someone had a good I can’t remember who now but a good tweet showing the 3600 call, I think was the December 20 to 3600 call. went off in Jan one at like 29 or something. And even at the lows here, it was at like 28. Right, it actually was down at take from the end. You think I’m down? 25%? What the heck’s going on?


Zed Francis  1:01:44

Yeah, we we’ve been showing in that symbol, like the 4000 foot the December one because we’re like, Yeah, but sorry. Yeah, no, no, because I mean, Same difference. I mean, it’s, like, the reason why we do the 4001 is we’re like, okay, like, what, if most people were coloring their equity portfolio at the start of the year, they like round numbers and the 4000. But it’s probably it’ll be they might actually, and like you said, like, it kind of went off in the year, the 4000 point about like, 28. And I’m not gonna quote it exactly, because I don’t know exactly what it is. But like, it’s probably like, yeah, 25 now, like, what, like,


Jeff Malec  1:02:22

how could that possibly be? Give me two minutes to talk about what you saw last week on how Vall has changed a little bit. Something a little interesting to you last week?


Zed Francis  1:02:38

Yeah. So this is this is not exactly new year to date. And I think I think part of the reason, additional reason why, as you said, you know, volatility on fixed rates, ie the specific options in the s&p 500, is flat to even down in the examples we just said, is a vast majority of active market participants. on the equity side, so who’s active on the equity side, like, obviously, like, you know, hedge funds, some mutual funds are active, but then there’s a lot of passive investment. The active guys that can actually trade options are kind of later risk. Like, if you look at PD reports, you know, from a UBS or Bank of America, places where people actually, you know, hedge funds, uses prime brokers, like their current gross, you know, both long and short. And net, you know, Long’s minus shorts, exposures are almost at all time lows. So all right, you have you have your active managers already kind of making a bet. The market is going lower. So why the heck are they going to like panic, buy puts like, that’s good. Like, they might be losing money, but they’re losing way, way, way, way, way less than, like what they’re like, theoretically benchmark to. So if that’s the seat of most active managers, like what’s been happening, when the market goes down, is people are rolling down, put strikes, which is a net selling volatility proposition, or maybe just monetizing some of their puts everybody in the US, which, again, is a net selling volatility proposition. So what we’ve seen is, during most down days, like, volatility doesn’t really expand. In fact, it kind of goes down. And that’s probably the mechanics behind it is people already positioned for the market to go down. And so when the market does go down, like you trim your winners, you do anything else, it’s just on the other side. What happened last week, is I do think the end of the quarter had a lot of forced liquidation events, mostly in commingled products with leverage, which I could go through a list of, you know, 100 Because, you know, again, a lot of commingle products with leverage, own both fixed income and equities. And that was, you know, a really bad quarter for both things. So hey, you gotta get yourself back to home base, which involves selling both things. So I think people were extra kind of under risk coming into this quarter. So it was not overly surprising that Monday, Tuesday last week was a substantial, you know, rally in both fixed income and equities or they both sides like other events. But what we saw in the options space on the back of that is a lot of call buying, I think last week, had in the s&p 570% More call volume than the previous week. And I think it was the highest call volume week, ever. Last week. Now, like the average stuff you gotta be careful with, because basically, every single trading day is the highest option trading day ever. So it’s like, you know, the relative is a little bit more important, we got to be careful with those ever statements, like you’re finding a new one every month just because there’s more training. But essentially, I think there was folks saying that my biggest risk is actually an extreme market rally. And I convicted by position, so I don’t want to auto go buy more stuff. But I need to hedge my lightweight position, I’m going to go ahead and buy call options to go ahead and do that. And last week, we saw essentially the biggest move higher, other than the couple of days around the invasion of Ukraine move higher and fixed rate volatility volatility was up a lot last week. And I think again, because you had panic, buyers of options, it was just your buying calls. Most people in their brains are like, Oh, it’s obviously panic buying puts. But it was, you know, outright option buyers and calls that were kind of price indiscriminate, like we just need to protect our portfolio from massive underperformance if this turns into some crazy, you know, 15% rally out of out of nowhere. I think last week was very interesting of showing the hands of the active managers in the marketplace that essentially like their their light on risk, and their relative performance, which you know, is how you’re gonna raise money and be successful like beyond this year is at risk to a massive market rally, not necessarily a market sell off.


Jeff Malec  1:07:11

What what do you think overall the risk and are they risking 1% In order to get exposure to in their call by like, that always makes a get the thing of like, I don’t want to get full in on equities here and by the outright Delta, one equities, but I’m, so I’m gonna buy the calls, but it always confuses me of like, what that math looks like


Zed Francis  1:07:30

how much you know, what, most most hedge funds that, you know, I’ve either worked in and we’re like, associate with the past, they do everything and like, shocks is how they would think. So like, instantly what’s gonna happen as a risk manager is gonna go up and say like, Okay, over the next month, like, here’s our, you know, mild, moderate severe shocks on both sides of the fence


Jeff Malec  1:07:54

up third, excellent shock. How much do we want?


Zed Francis  1:07:57

30%. But like, yeah, like, you know, teens over one month, a team’s rally in the s&p 500 How much do we expect to underperform? And then they’re gonna say, like, okay, like, hey, you know, portfolio management team, we need to find 300 basis points support performance, if the market were to rally 13% over the next month, obviously, he’s making up numbers and pm team says, All right, like if you’re telling me a 13% rally in one month, and I need to find 300 basis points, performance, heck, I’ll just go buy these calls. Like, that’s the easiest way to go ahead and achieve that without changing my core portfolio very much. And so the the amount of premium use to achieve that is kind of secondary. What do I need to do to like, make my risk manager happy and keep all the positions that I like,


Jeff Malec  1:08:50

but by definition, probably something rather small in terms of that, right? Like,


Zed Francis  1:08:54

like, correct, but like, we’re probably not inconsequential. Because like, again, motility was was kind of high. So it’s like, you’re paying some real premium to like,


Jeff Malec  1:09:03

like, oh, we want to participate in this, we’re gonna buy these cars, we’re like, well, you’re guaranteed to lose some of that money on that.


Zed Francis  1:09:10

That’s like, I don’t know like 3040 50 basis points of overall fun and premium and the answer is like that happens once in the market goes down. You feel like a king you’re like, you know, I maintain my position and like, I only burned a little bit like It’s like where it gets painful is nothing happens. Or the market only goes up 5% Right now you work it’s a five and I lost money on those


Jeff Malec  1:09:35

books. Yeah. Awesome. Well, I’ll let you go. I know you’re single dad tonight. So good luck with that. Pop in a movie give him some chicken bones soaked in bourbon. That’s what my God I’m,


Zed Francis  1:09:48

I’m just I’m going for the trick of you know, it’s, as you said, it’s rainy and dark outside. So just like at 630 be like, Oh, it’s bedtime. Like, like out the window. It’s dark.


Jeff Malec  1:10:01

Alright Zed, I appreciate it. We’ll talk to you soon and meet up here in Chicago.


Zed Francis  1:10:07

Alright sounds good, thank you

The performance data displayed herein is compiled from various sources, including BarclayHedge, and reports directly from the advisors. These performance figures should not be relied on independent of the individual advisor's disclosure document, which has important information regarding the method of calculation used, whether or not the performance includes proprietary results, and other important footnotes on the advisor's track record.

Benchmark index performance is for the constituents of that index only, and does not represent the entire universe of possible investments within that asset class. And further, that there can be limitations and biases to indices such as survivorship, self reporting, and instant history.

Managed futures accounts can subject to substantial charges for management and advisory fees. The numbers within this website include all such fees, but it may be necessary for those accounts that are subject to these charges to make substantial trading profits in the future to avoid depletion or exhaustion of their assets.

Investors interested in investing with a managed futures program (excepting those programs which are offered exclusively to qualified eligible persons as that term is defined by CFTC regulation 4.7) will be required to receive and sign off on a disclosure document in compliance with certain CFT rules The disclosure documents contains a complete description of the principal risk factors and each fee to be charged to your account by the CTA, as well as the composite performance of accounts under the CTA's management over at least the most recent five years. Investor interested in investing in any of the programs on this website are urged to carefully read these disclosure documents, including, but not limited to the performance information, before investing in any such programs.

Those investors who are qualified eligible persons as that term is defined by CFTC regulation 4.7 and interested in investing in a program exempt from having to provide a disclosure document and considered by the regulations to be sophisticated enough to understand the risks and be able to interpret the accuracy and completeness of any performance information on their own.

RCM receives a portion of the commodity brokerage commissions you pay in connection with your futures trading and/or a portion of the interest income (if any) earned on an account's assets. The listed manager may also pay RCM a portion of the fees they receive from accounts introduced to them by RCM.

See the full terms of use and risk disclaimer here.