Exploring the Trend in Trend Following: Q Group Presentation

David M. Modest, Ph. D. October 19, 2020

STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. Disclaimer

This presentation is for the Q Group Fall 2020 October 19, 2020 and is for information purposes only. The information in this presentation is believed to be accurate as of the date set forth on the cover. Osprey Bay Capital is under no obligation to update this information. This presentation does not confer any rights on the recipients or impose any obligations on Osprey Bay Capital. This presentation is provided for discussion purposes only, is only a summary of certain information, is not complete, does not contain certain material information and is subject to change without notice. No assurances can be given that investment objectives will be achieved, and investment results may vary substantially on a quarterly or annual basis. As with any hedge, private equity, or venture fund, past performance cannot assure any level of future results. Actual returns for each investor may be different due to timing of investments. This presentation is neither an offer nor a solicitation to buy an interest in any fund managed by Osprey Bay Capital, which can only be made pursuant to a confidential private placement memorandum and only in a jurisdiction where permitted. The information contained herein is confidential and is intended solely for conference participants. Delivery of this presentation to anyone other than the recipient or his designated representative is unauthorized, and any other use, reproduction, distribution or copying of this document or the information contained herein, in whole or in part, without the prior written consent of Osprey Bay Capital is strictly prohibited.

PAGE 2 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Background

STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. Research Motivation

Bertrand Russell: ``When you are studying any matter or considering any philosophy ask yourself only what are the facts and what is the truth that the facts bear out. Never let yourself be diverted either by what you wish to believe or by what you think would have beneficent social effects if it were believed, but look only and surely at what are the facts.’’

• Research grew out of twenty months as Chief Investment Officer of AlphaSimplex Group (ASG) LLC from December 2016 to August 2018

• ASG (a Natixis subsidiary) focuses on liquid alternative strategies (i.e. strategies with daily liquidity). The two primary strategies are: - Managed Futures: multi-model, multi-horizon pure trend following strategy implemented using futures and forward contracts - Global Alternatives: seeks to replicate the exposures of hedge funds to a diverse set of risk premia

• Currently working on four papers that grew out of my experience there

PAGE 4 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Diminishing Returns for the Managed Futures Industry

Average returns have decreased as assets-under-management (AUM) in Managed Futures strategies have risen from roughly $300MM in 1980 to ~$300BB today.

Average Returns SG Trend BTOP 50 Risk-Free Start Date Jan 2000 Jan 1987 1980s 22.2% 6.5% 1990s 9.3% 4.8% 2000s 8.6% 6.6% 2.7% 2010s 2.0% 1.0% 0.5%

Direction of performance and fund flows consistent with Berk and Green (JPE 2004) …. although adjustment period appears lengthy

Note: Average annual returns on the SG Trend and BTop50 indices computed from return data on BarclaysHedge website. The risk-free rate data is taken from Ken French’s website.

PAGE 5 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Difficult Investing Experience for Retail Investors

Experience for investors has been worse than the time-weighted average returns

CUMULATIVE PROFITS AND FEES SINCE INCEPTION

AlphaSimplex AQR

Managed Managed MF High AQR Total Futures Futures Volatility (MF) Inception Date July 2010 Feb 2010 August 2013

Est $ Profit -$158.8 -$1,050.2 -$166.1 -$1,216.3

Est $ Mgmt Fees $220.4 $673.9 $43.9 $717.8

Est $ Total Fees $270.4 $830.9 $50.4 $881.3

Note: Cumulative profits from inception through June 2020.

Since the beginning of 2016, AQR’s retail investors have lost ~$2.4BB in their Managed Futures products (regular and high-volatility) …. and ASG’s retail investors have lost ~$300MM in their retail products

Note: Estimated profits are derived from return and AUM data provided in the CRSP mutual fund database. Estimated fees are derived from CRSP AUM data and fee disclosures reported on the SEC Edgar database. Profits and fees are cumulative estimates since inception based on end-of-month values through June 2020.

PAGE 6 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Back to Basics

STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. Back to Basics I

What do we truly know and what are we assuming? Explicit Assumptions Implicit Assumptions (examples)

• Buy what has gone up and • Expected utility is maximized by sell/short what has gone done following a momentum strategy • Even if you think there is a 95% chance that an asset which has gone down will rebound, you still want to be short • Trend follower preferred an Italian 10-year bond trading at 80 basis points in Sept 2019 to the same bond trading at 183 basis points in August 2019

• Use multiple lookback • Optimal weighting of the windows is windows to assess trend relatively unchanged over time direction • Barbell approach with most of the weight <3 and >8 months • Capital decisions are based on • Benefits of increased diversification risk rather than notional outweigh leverage risks associated allocations with leveraged bond and other leveraged positions PAGE 8 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Back to Basics II

What do we truly know and what are we assuming … continued Explicit Assumptions Implicit Assumptions (examples)

• Historical volatility and correlations provide useful forward-looking estimates • Negative gamma trading strategy is not too costly given the inverse relation between price & volatility • Allocate risk equally between • Equal risk weighting (a.k.a. risk parity) 4 major asset classes improves diversification (relative to (equities, bonds, currencies notional weighting) and reduces tail and commodities) based on risk trend signals • (c.f. Bridgewater All Weather Strategy)

• Historically over the last 40 years, managed futures have been structurally long equities and long bonds • S&P500 index 111 on 1/1/80 and 3408 on 10/5/20

PAGE 9 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Back to Basics III

What do we truly know and what are we assuming … continued Explicit Assumptions Implicit Assumptions (examples)

• Ten-year U.S. yields dropped from ~16% in the early ‘80s to ~8.5% at the beginning of the ‘90s to ~4% at the beginning of the new millennium to < 1% today

• Equal risk weight of long equities and long bonds has provided a natural hedge to equity crash risk

• Historically, you have been paid to receive this crash protection (given the upward sloping yield curve) • ~$15 trillion of global debt has negative

PAGE 10 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Back to Basics IV

What do we truly know and what are we assuming … continued … continued Explicit Assumptions Implicit Assumptions (examples)

• Equal risk weighting has desirable mean-variance properties when the asset classes have roughly identical ex-ante Sharpe ratios (ceteris paribus)

• Allocate risk equally within • The diversification potential of asset classes to individual investing in many different individual assets assets is not severely impinged by the integration of global markets • There is sufficient liquidity at the individual asset level

PAGE 11 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Some Binomial Observations

STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. Simple Binomial Framework

Hypothetical Profits to a Long-Only Investor

$40

$30 Assume constant $20 notional investment of $20 $100 over time $10 $10 $0 Binomial tree shows $0 $0 cumulative profits as of given date -$10 -$10 -$20 -$20

-$30

-$40 Date 0 Date 1 Date 2 Date 3 Date 4

STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Probability Distribution of Long-Only Profits

Assume heads and tails are equally likely

40.00%

35.00%

30.00%

25.00%

20.00%

15.00%

10.00%

5.00%

0. 00% -40 -20 0 20 40

PAGE 14 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Trend Following Profits with a Fair Coin

Profits associated with sixteen possible outcomes for long- only and (fast) trend following strategies.

Consider a (fast) trend- Table 1: Hypothetical Outcomes and Payoffs

following strategy where the Trend Outcomes Cumulative Profits trend follower starts long the Fast market. If heads is tossed, the Path Long Only Trend Date 1 Date 2 Date 4 Date trend follower stays long, but if 3 Darte Profits Profits tails is tossed the trend follower goes short. This is a fast trend 1 u u u u 40 40 2 u u u d 20 20 following strategy in that next 3 u u d u 20 0 period’s position only depends 4 u d u u 20 0 on the outcome of this period’s 5 d u u u 20 0 coin toss. 6 u u d d 0 20 7 u d u d 0 -20 8 u d d u 0 0 9 d u u d 0 -20 10 d u d u 0 -40 GREEN indicates positive 11 d d u u 0 0 outcome (profit) for the 12 u d d d -20 20 strategy and RED indicates 13 d u d d -20 -20 negative outcome (loss). 14 d d u d -20 -20 15 d d d u -20 0 16 d d d d -40 20

PAGE 15 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Trend Following Generates Crisis Alpha

By construction, if large losses over time are the result of repeated negative events, trend following will provide crisis alpha.

Figure 3: Average Trend Profit and Crisis Alpha Conditional on Long-Only Profit $70

$60

$50

$40

$30

$20

$10

$0

-$10

-$20 $40 $20 $0 -$20 -$40 Trend Profit Crisis Alpha

PAGE 16 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Observation #1

For both strategies, maximum profit = $40, maximum loss = -$40, expected profit = $0 and the variance of profits = 400

In this simplified binomial setting with no trend in asset prices, the trend-following strategy:

• Has the same expected profits and variance of profits as a long-only investment strategy.

• The dynamic nature of the trend-following Quantstrategy shapes the return distribution and substantiallyAnalysis changes WHEN the profits and losses occur

PAGE 17 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Observation #2

Trend Following produces crisis alpha even in an efficient market (when large losses are due to repeated negative outcomes).

Although there is nothing “smart” about this simple trend-following strategy, it is able to generate “crisis alpha’’ and prevent losses in those states of the world when the long-only investor is most seriously affected—despite the absence of predictable trends in asset prices. Quant Analysis

PAGE 18 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Long Call Option Profits

Also well known that other dynamic strategies can change the timing of when you make and lose money

Gross Net Figure 4: Cumulative Hypothetical Profits to Option Option Long-Only and Long Call Investors Payout Payout

$40 $30 $25.625 Consider a call option $30 with an $20 $20 $10 $5.625 exercise price of $10 $10 $10 Quant $0 $0 $0 $0 -$4.375 Analysis -$10 -$10

-$20 -$20 $0 -$4.375

-$30

-$40 $0 -$4.375 Date 0 Date 1 Date 2 Date 3 Date 4

PAGE 19 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Long Call Option Profits

Owning a call option also generates crisis alpha

Figure 5: Average Long-Call Profit and Crisis Alpha Conditional on Long-Only Profit $70

$60

$50

$40

$30 Quant $20 Analysis $10

$0

-$10

-$20 $40 $20 $0 -$20 -$40 Long Call Net Payoff Crisis Alpha

PAGE 20 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Observation #3

Owning a call option produces crisis alpha although no abnormal profit in an efficient market.

Buying (and selling) options is an example of another dynamic investment strategy that can shape the conditional distribution of profits—i.e., when profits occur—even though the first two moments of the unconditional distribution are unaffected.

Quant Analysis

PAGE 21 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Trend Following Profits with an Unfair Coin

Profits associated long-only, fast- and slow trend following strategies when probability of an up market exceeds the probability of a down market.

Table 3: Hypothetical Outcomes and Payoffs

Fast trend-following Fast Trend Outcomes Slow Trend Outcomes Cumulative Profits Periods 2-4 strategy depends only Initial Position: Neutral Initial Position: Neutral Fast Slow on last period’s Path Long Only Trend Trend Date 1 Date 2 Date 4 Date 1 Date 2 Date 4 Date outcome. Slow trend 3 Darte 3 Darte Profits Profits Profits strategy depends on 1 u u u u u u u u $30 $30 $20 last 2 period’s 2 u u u d u u u d $10 $10 $0 outcomes. 3 u u d u u u d u $10 -$10 $0 4 u d u u u d u u $10 -$10 $0 5 d u u u d u u u $30 $10 $10 6 u u d d u u d d -$10 $10 -$20 7 u d u d u d u d -$10 -$30 $0 GREEN indicates 8 u d d u u d d u -$10 -$10 -$10 9 d u u d d u u d $10 -$10 -$10 positive outcome 10 d u d u d u d u $10 -$30 $0 (profit) for the 11 d d u u d d u u $10 $10 -$20 strategy and RED 12 u d d d u d d d -$30 $10 $10 13 d u d d d u d d -$10 -$10 $0 indicates negative 14 d d u d d d u d -$10 -$10 $0 outcome (loss). 15 d d d u d d d u -$10 $10 $0 16 d d d d d d d d -$30 $30 $20

Expected Profit Probability of Heads = 50% $0.00 $0.00 $0.00 Probability of Heads = 65% $9.00 $2.70 $2.00

PAGE 22 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Observation #4

Trend Following can generate positive expected returns and deliver crisis alpha even in an efficient market.

In general, trend-following strategies will earn positive profits—even in efficient markets—as long as asset prices have a consistently positive (or negative) trend. The dynamic positioning of the strategy enables it to earn positive profits during sustained and predictable market moves in EITHER direction --- as long as the

moves playQuant out over a sufficient period of time. Analysis

PAGE 23 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Looking Back at the Beginning of 2019

Why Algo Traders See Looming 'Chaos' in the Markets: Computer-driven funds are now short sellers of nearly every asset class BY MARK KOLAKOWSKI (Updated Jan 15, 2019)

‘’As computer-driven algorithmic trading becomes an increasingly more important factor in the market, the recent massive shift towards a bearish stance among a subset of these programs has worrying implications. “This is like the chaos bet,” according to Kathryn Kaminski, chief research strategist and co-manager of a managed futures portfolio at AlphaSimplex Group, as quoted by The Wall Street Journal. “Pretty much any way you run the models, you end up net short a lot of asset classes," Kaminski added, noting that this is the biggest swing from bullish to bearish amongQuanttrend-following algorithms since 2007 and 2008 (see below). That, of course,Analysis was the era of the subprime meltdown, the financial crisis, and the most recent bear market for the S&P 500 Index (SPX).’’ Source: The Wall Street Journal

KEY QUESTION:

Did ``Managed Futures Traders See a Looming Crisis’’? or were ``They Positioned Short in Case There is a Crisis’’?

PAGE 24 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Modern Portfolio Theory Revisited

• Construction of the minimum variance portfolio does not require Expected Returns as an input. It only requires estimates of variances and covariances. • It is the maximum “defensive” portfolio. • Other portfolios on the efficient frontier trade-off “offense” and “defense”. • Is Trend Following more “offensive” or “defensive” in spirit? (Defensive in not wanting to miss large moves in EITHER direction)

PAGE 25 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Some Empirical Observations

STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. A Toy Trend Following Model

A toy trend following model can be used to shed light on the benefit / cost of trend following’s dynamic positioning

• Strategy implemented across ~50 different futures markets spanning four asset classes: commodities, equities, fixed income, and foreign exchange • Data starting in ~1980 • No adjustment for transaction costs or management fees • Five single-horizon trend following strategies with lookback horizons of 21, 63, 126, 189 and 252 days • Long (short) assets where the cumulative price changes are positive (negative) over the lookback window • Equal risk weight across asset classes and individual assets - All assets and asset classes normalized to 10% ex-ante volatility - Within commodities, equal risk weight across agricultural, energy and metals • Multi-Horizon strategy equally weights the five single-horizon strategies

PAGE 27 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Active / Passive Decomposition of Returns

Gradually allow the strategy to become more dynamic

• Static Risk Parity (SRP): Choose the mode of the position signs; keep variances and covariances fixed over the entire sample. Hence, position sizes static over time.

• Dynamic Risk Parity (DRP): Allow the sign of the positions to change over time but keep all normalizing constants (that normalize to keep constant individual asset, asset class and portfolio volatilities constant) fixed over the entire sample

• Stochastic Individual Volatilities (SIV): Allow individual asset volatilities to vary over time

• Stochastic Asset Class (SAC) Volatilities: Allow asset class volatilities to vary over time (and hence individual asset correlations)

• Dynamic Trend Following (DTF): Allow all normalizing constants to vary

PAGE 28 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. The Value of Active Management I

Little evidence that dynamic positioning adds to profits Dynamic Trend Following Static Risk Ability to Short Parity Excess Returns: All Asset Classes

Cost of dynamic positioning Lookback almost 5% per year Horizon SRP DRP SIV SAC DTF

21 days 15.0 8.7 9.6 7.9 8.6 63 days 14.9 11.7 12.4 10.1 10.6 126 days 14.1 11.5 12.4 9.1 9.2 Position do not change not do Position

over the entire sample period 189 days 14.2 13.5 14.7 11.2 11.8 252 days 13.6 15.5 16.7 12.6 13.0

PAGE 29 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. The Value of Active Management II

… especially within equities …. Dynamic Trend Following Static Risk Ability to Short Parity Excess Returns: Equities Cost of dynamic positioning of equities over 2% per year Lookback Horizon SRP DRP SIV SAC DTF

21 days 4.1 0.2 0.4 0.5 0.6

63 days 4.0 1.2 1.8 1.2 1.3

126 days 3.9 2.6 3.2 1.8 1.6

189 days 3.8 3.3 4.1 2.5 2.6

252 days 3.7 3.1 3.9 2.5 2.6

PAGE 30 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. The Value of Active Management III

Fixed income contribution to overall is Dynamic …. And Fixed Income profits is enormous over this ~40 year period Trend Following Static Risk Ability to Short Parity Excess Returns: Fixed Income Cost of dynamic positioning of fixed income close to 6% per year! Lookback Horizon SRP DRP SIV SAC DTF

21 days 7.8 5.0 4.6 3.1 3.4

63 days 7.9 4.3 3.6 2.5 2.6

126 days 7.8 3.8 3.3 2.0 2.0

189 days 7.9 5.0 4.4 2.7 3.0

252 days 7.8 5.5 4.6 2.9 3.0

PAGE 31 STRICTLY CONFIDENTIAL. NOT FOR DISTRIBUTION. PREPARED FOR THE EXCLUSIVE USE OF THE INTENDED RECIPIENT. Concluding Remarks: Trend Following

• Trend following profits are not per se inconsistent with efficient markets.

• Trend following, through its dynamic positioning, affects when profits and losses occur.

• Trend following will (by construction) provide crisis alpha provided that deep losses are the result of repeated negative outcomes and not the result of a “crash”.

• The profitability of trend following is not robust to changes in the speed at which information is disseminated in the economy

• Trend following is a defensive-oriented strategy in that the active part of the strategy is more defensive-oriented (preventing losses in down markets) than offense oriented (generating additional profits).

• Trend following has greatly benefited from the roughly forty-year decline in interest rates and the diversification benefits that come from allocating risk capital rather than notional capital.

THANK YOU!

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