Corey Hoffstein, CIO, Newfound Research

[00:00:02] Hello, this is Dean Curnutt and welcome to the Alpha Exchange, where we explore topics in financial markets associated with managing risk, generating return, and the deployment of capital in the alternative investment industry. Corey Hoffstein, the co-founder and CIO of Newfound Research, is among the investors expanding the financial product set available to the RAA community.

[00:00:29] A client segment that has long been fed a diet of 60-40 exposures, the high net worth community is finding the need to diversify beyond stock and bond exposure. Using their innovative approach to return stacking, Corey and team are making alternative sources of risk premium accessible and packaged in ETF format.

[00:00:50] Through our conversation, we first learned that from a behavioral standpoint, introducing entirely new securities with new exposures has been a challenging ask. With return stacking, the diversifying strategy is put on top of an existing stock or bond exposure packaged in one security. We discussed Corey's recent white paper comparing the risk characteristics of corporate bonds to that of merger arbitrage and how each exposure interacts with stock and bond markets.

[00:01:18] He finds the correlation of risk returns to those of the equity market are lower than corporate bond spreads to equities. We also review a realm of trading strategies that Corey has focused on substantially over the years, trend following. He walks through the manner in which trend can be defensive and how it behaved specifically over this recent significant market drawdown.

[00:01:40] We finish by getting some of Corey's thoughts on the broad topic of risk premiums and which, like merger arm and vol selling, ought to be persistent sources of compensation. I hope you enjoy this episode of the Alpha Exchange, my conversation with Corey Hofstein. My guest today on the Alpha Exchange is Corey Hofstein.

[00:02:02] He's the founder and the CIO of Newfound Research, a firm delivering quantitative investment solutions to individuals and institutions. Corey, welcome back to the Alpha Exchange. Dean, thank you for having me back. I feel privileged to make a second appearance here. I'm happy to have you back. We're connecting amidst a 27 VIX, which sounds awfully high in the context of the history of the VIX, but half its level from its peak two short weeks ago.

[00:02:31] So things are very much in flux in the markets. As we get our conversation going, tell us just a little bit about the work you're doing at Newfound Research, your impetus for deciding to launch the firm and its suite of products. Yeah, so Newfound Research, which I co-founded back in August 2008, got its origins as a quantitative research firm.

[00:02:56] Over time, we have expanded our offerings and really moved from the research space into the asset management space. In our DNA has always been a focus on alternative diversifying asset classes and strategies. And one of the big pivots we made in 2017 was asking ourselves the question, how can we deliver those strategies, those asset classes more efficiently and effectively to our clients who are predominantly independent wealth managers and financial advisors?

[00:03:27] We looked around and saw sort of the big problem that they were facing ultimately was that adding diversifiers to a portfolio is what we would call this problem of addition through subtraction. They had to sell core stocks and bonds to make room for these alternatives, whether it's an asset class like gold or a strategy like merger ARB or trend following. And it creates these two problems. One is a mathematical problem.

[00:03:51] You have to figure out what your capital market assumptions are, how much stocks and bonds are you selling for whatever you're adding. And then the second is behavioral. You're asking as an advisor, your clients to trust you to move away from these things that they know and are comfortable with and are more transparent and typically more tax efficient into these strategies that are more opaque, less tax efficient, that they just don't have as good a grasp on.

[00:04:17] And you end up with this behavioral friction of difficulty of clients to stick with it. And so what we saw in practice is in the 2010s when diversification really didn't work, diversification was largely abandoned by advisors. Our solution to this problem actually was something we drew from the institutional space, an idea that goes back 40 years called portable alpha. It's when it's done in the institutional space.

[00:04:40] The idea is betas are replaced through capital efficient derivatives, whether it's futures or swaps or sometimes even options, depending on the efficiency need. And then you take the freed up capital and you invest in whatever alternative asset strategy or alpha that you want to pursue. And in doing so, you effectively are able to keep your beta and add that alpha on top, hence the name portable alpha. We generalize the concept of something we call return stacking.

[00:05:08] I'll do credit to my colleague, Rodrigo Gordillo, who came up with that phrase. And the idea of return stacking is more generalized, which is to say, you know, if you give us a dollar, we're going to give you a dollar of core stocks and bonds and stack the returns of an alternative asset strategy on top, whether it's a dollar of gold, a dollar of merger arbitrage, a dollar of managed futures.

[00:05:31] The list goes on. And the idea is by taking that concept and putting it into a tickerized solution, whether it's a mutual fund or an ETF, you help allocators be able to introduce those diversifiers in a way where they don't have to sacrifice the core stocks and bonds anymore. They can maintain that strategic exposure, which we think helps solve both problems. It's not the either or math problem anymore. It's a yes and to alternatives.

[00:05:58] And from a behavioral perspective, that alternative no longer sticks out as a unique line item. It's blended into a single ticker solution with the core beta that clients know and love. And so we're really trying to solve two problems, one, which is a theoretical mathematical portfolio optimization problem. And we think it's an important solution. And then the second is the real world practical behavioral issues that come with allocating to alternatives.

[00:06:24] And so we've launched a whole suite of funds, mutual funds ETFs and even have an ETF in Canada today, all under the return stack brand. Started two years ago and have gone from zero to just over 800 million in assets under management over that time. Wonderful. And the RIA space is a large space. It's been around for a long time. And at least the, you know, the reputation is basically for simplicity.

[00:06:50] It's some version of 6040 keeping people adequately invested, but giving them a little bit of defensive exposure through bonds. And so firms like yours are introducing new strategies, new sources of diversification, all of which will serve as good topics of conversation for us. A couple of areas I wanted to follow up on. One is you mentioned this idea of portable outfit goes back a ways.

[00:07:17] I'm remembering to my days, God, it had to be early 2000s when 13030 was kind of all the rage. You know, the GFC, the GFC is enough to, you know, really destroy a lot of things. But I think that brand of strategies took a hit during that period of time.

[00:07:39] So 13030 took a, you know, it was a difficult time period for that strategy through the GFC as happened to so many strategies that even employed a dose of leverage. Walk us through a little bit of the evolution of, you know, things like portable alpha and how you arrive at return stacking, the ways in which it's different and maybe the lessons that markets have taught us along the way that you're incorporating into the strategy now.

[00:08:07] Yeah, portable alpha was something that was really popular and growing in popularity in the early 2000s, early to mid 2000s. Again, it is something that was started at PIMCO back in the 1980s. So even even in the early 2000s, it was already 20 years old as a concept, but it really started to get adopted en masse by institutions. And the way they implemented it is really important to understand why it unraveled.

[00:08:36] Some of this is the 13030. Some of it is just the way it ultimately was structured. When you had these institutions who were saying, let me replace some beta to free up cash. And then I'm going to take those cash, that cash, and I'm going to invest it in attractive hedge funds. So they would say, take their S&P 500 exposure where they felt that they couldn't find alpha through security selection. And they'd go to a bank and they'd get a total return swap on the S&P 500. And they'd only put aside a little bit of cash.

[00:09:06] They'd take their freed up cash and they'd go invest it in a hedge fund that they thought would do well, generate alpha. And in normal market environments, that's fine. The problem is when you hit a crisis environment, when the S&P 500 starts to sell off and eats through all your margin capital, suddenly you get a margin call. Right? And then what you need to do is you need to rebalance your portfolio and get your money out of the hedge fund to free up the cash to maintain that beta exposure.

[00:09:35] But if the hedge fund is losing money at the same time, which was happening in a liquidity crisis like 2008, or you were investing in things that actually had a similar drawdown correlation profile, or the hedge funds started to gate and lock redemptions, you had this huge liquidity and return mismatch. Right? And so what ended up happening were really two problems, right? People look at something like leverage and they consider it to be dangerous.

[00:10:02] Leverage in and of itself is just a tool that amplifies both the good and the bad. But you do find leverage at the scene of the crime of almost every major crisis. But in my opinion, it's never there alone. It's always there with concentration risk and it's always there with illiquidity. Right? When you look at someone like a Bridgewater who uses a tremendous amount of leverage, but they use that leverage to really focus on diversifying across a set of liquid bets,

[00:10:31] that portfolio ends up being much more resilient across economic cycles than someone who's using the same amount of leverage to double down on the same bets. And so the problem with Portable Alpha in 2008 was really the structure of implementation. One of the ways in which it's fundamentally changed over the last 10 or 15 years is, one, the institutions still doing it tend to be hoarding not on top of their equities, but hoarding on top of their bonds. Right? Why is that important?

[00:11:01] Well, at least until recent years, you're much less likely to get a margin call on your bonds. Right? Particularly if you had some short duration bond exposure in your strategic portfolio. If you had 10% exposure, 20% exposure to one to five year U.S. Treasuries, great. That's a great source of capital that you can port on top because you can get it efficiently with a swap or futures exposure.

[00:11:28] And you don't have that much margin call risk compared to something like the S&P 500 that's going to be a lot more volatile. And then two, they tried to be a lot more sophisticated about what they were porting on top.

[00:12:10] So, you know, the hedge funds are now saying, well, we'll actually do both. You tell us what custom benchmark you want and we will manage the beta exposure for you and do all the rebalancing within the same vehicle. And so that helps solve some of the liquidity mismatch problem and the operational rebalancing needs on the institution.

[00:12:33] But it also potentially helps solve the behavioral bias again by putting the alternative with the beta in a single line item and getting those reported back to the institutional board as a single thing. Hopefully makes it easier for them to stick with the alternative during periods of underperformance relative to the beta. So you're seeing that turnkey model pick up. And it's that turnkey model that we've used as a structure to implement within what we brought to market in the mutual fund and ETF vehicles.

[00:13:02] There's an old Mark Twain quote that I've come to really enjoy thinking about in terms of diversification. He says, always better to scatter one's money and attention. And, you know, I think that's really what in markets diversification is somewhat about. It's to try to sprinkle it around, right? Don't have all your eggs in one basket.

[00:13:25] And some version of that is about finding assets that are different, that have respond to different types of exposures, you know, trading strategies that yield results that might not mimic the S&P. You and I have talked over time about defensive strategies like buying options and so forth. Trend following is something that you've had, you've done a lot of work on.

[00:13:53] And it's very clear you, you know, have done a lot of thinking and think strongly about trend following. So we're just coming through at its maximum. It was a 19% drawdown in the S&P. That's a doozy, right? There's very few comps to that. You can, you know, you can look at 2022, of course, COVID, the GFC, the tech bubble unwind of 2000. But there's just not that many like that.

[00:14:22] And I'm curious if you can just give us an overview of the implementation and performance of certain trend following strategies and the way in which they either did or, you know, perhaps didn't enough act defensively. How did trend do in this last drawdown? And so trend as a category is one in which there's a tremendous amount of dispersion among managers, right?

[00:14:51] So when we talk about trend following, the basic premise really hasn't changed in 40 or 50 years. It's when you have a market that's going up, you go long. When there's a market that's going down, you go short and try to profit from the continuation of that trend. And you're doing that in equity markets, currencies, commodities, rates. You know, as many global asset classes as you can. From that simple premise, though, there's a large number of degrees of freedom in the implementation.

[00:15:21] So, for example, what markets are you trading, right? Are you tilted towards certain sectors and away from others? Are you more commodity heavy? Are you trading a long tail of alternative asset classes like apples in China, right? Are you trading only those alternatives? Or are you more tilted towards the higher capacity markets like oil and gold and Japanese bonds?

[00:15:48] What's the speed of the trend you're trading, right? And here, this is where there's a lot of intuition that option traders will have, right? Trend following in and of itself can simply be thought of as, you know, in a sense like the delta replication of a straddle. There's actually some mathematical connection there. And so you can imagine a very fast trend follower is very much like a very short term option, whereas a slow trend follower is much more like buying a long term option.

[00:16:18] And so you can imagine the response profile of that trend follower is going to be very intuitive for people who are used to buying short term versus long term options and the response profile of those options to different market events. And so all of these things, what ends up happening is people look at trend as a category. But within that category, you know, you can look at the top 10, top 20 trend followers.

[00:16:40] And in any given year, the performance dispersion can be and is quite consistently 20 to 30 percentage points wide between the best and the worst performing with the standard deviation being north of 5 to 10 percentage points. So it's a very meaningful dispersion. So when I talk about trend on average, the individual experience can be quite different than the average experience.

[00:17:04] But the reality is most people look towards the category average like a soft trend index or a Barclays CTA index as being how they see the performance being. So that said, right, trend is going to be a responsive strategy. And so it's important to set sort of the table with what was happening pre this tariff tantrum. By the way, I don't know if people have come up with what this event should be called yet. I feel like every market event has a name. I'm calling it the tariff tantrum. Maybe that'll catch on.

[00:17:34] So pre this tariff tantrum, right, you had strong international equity market returns. Flat-ish U.S. equity market returns. And here when I talk about this, I'm talking about like over a six, nine month rise. And you were starting to see U.S. equities sell off. You still had a very strong dollar. You still had very strong returns in gold, silver, copper.

[00:17:58] The energy complex was still slightly long to my recollection, but it wasn't very long. Right. And then you had bonds, which were continuing. I mean, they just got whipsawed to death in 2024. And it was much the same picture going into 2025. As you saw the market roll over, right, you were still holding those international longs. That got crushed. You were still very long the dollar. That got crushed.

[00:18:25] And in the first throws of the tariff tantrum, gold, silver, copper were getting crushed. And so trend was going down at the exact same time as equity markets. And I think that caught some people by surprise who think of trend as a defensive strategy. But historically, trend does not do well during the first 10% drawdown of equity markets. Trend is a responsive strategy.

[00:18:52] It needs time for that delta profile to change. It needs time for those trends to roll over. And so what you saw after two or three days was actually trend strategies went from these inherited legacy past market cycle positions to almost having no exposure across energies, currencies, bonds, equities. The only thing that was outstanding really was a meaningful position in gold, copper, silver.

[00:19:21] And I'm talking very generically here. Like, I don't speak for every trend follower. I'm talking, you know, but on average, this is sort of what it looked like as far as I can tell. And, you know, two or three days after the tariff tantrum began, trend followers were largely de-risked across all markets, really except for gold. As we've walked forward since then, those gold, copper, silver positions have largely remained on. You now start to see some short dollar positions emerging.

[00:19:50] Those international equity positions, U.S. equity positions have really gotten squeezed towards zero. And there's not a lot going on in bonds either. So, you know, we've picked up a pretty big short dollar positions, long gold position. But in the rest of the sectors, it's still sort of wait and see for emerging trends. You know, what I find so interesting about markets is the extent to which an asset can start to take on

[00:20:20] unique risk characteristics at a given point in time. And gold is one of my favorites to talk about, to look at. You know, it's some expression of we don't know what's going on here. You know, it's kind of not a vote for, it's a vote against. It can pick up a VIX-like characteristic. You know, it obviously is inversely correlated to the dollar. That is consistent. It's often inversely correlated to the level of rates.

[00:20:50] This time it rallied even as, you know, bonds backed up and rates were flat to higher. Right. And I think it was more of this, call it flight to safety expression of discomfort as to, you know, what's going on. But risk premium is, you know, is a common thread across some of your work. You can't make money without taking some kind of risk premium.

[00:21:16] And I think at the heart of return stacking is this idea, and you've talked about stacking on top of bonds. So maybe we can start there with sort of some of the assets that you've built portfolios around that stack on top of bonds and the idea of risk premium. So one of the examples you talked about in one of your white papers was looking at corporates

[00:21:45] versus merger ARB. I'd love for you to explore, you know, how you started thinking about that, what your results have been. Is that an implemented vehicle now? So can I go out and get that exposure? I'd love to learn more about your dive into the world of risk ARB. Yeah, so just to step back, you know, one of the things that I've sort of developed a view

[00:22:12] on in my career over the last 16 years is that true alpha is probably near impossible to implement in a mutual fund or ETF vehicle. There are just structural limitations that make it very difficult. And so when I look at bringing products to market in those vehicles, my goal is to bring alternative risk premium and novel beta.

[00:22:36] And I think for people who just start with a 60-40, right, their portfolio is kind of agnostic as to whether you're introducing like a true alpha or a novel beta. At the margin, it's different, but there's still quite a bit of benefit to introducing a truly novel beta to a just generic 60-40 portfolio. And at the end of the day, our goal is to say, look, you know, probably most of what can be implemented in a mutual fund or an ETF is like a 0.3, 0.4 sharp or information ratio type strategy.

[00:23:05] But we should still try to collect as many of those as possible. And so as we were thinking of how do we package different ideas together, what we wanted to do was find these high conviction strategies, risk premia that we really believed would be long-lasting risk premia and try to package them together in a way that would be palatable to the market. And merger arb is one of those strategies, right? For people unfamiliar with merger arb, the basic idea of this strategy is when a public company,

[00:23:35] when it's announced that they are going to get acquired, their stock price typically jumps up towards the acquiring price, but not all the way there. And that sort of spread that's left represents a risk premium. And it's a risk premium related to the probability of the deal closing and the amount of time it's going to take for the deal to close. And the more uncertainty there is, the greater the risk premium is.

[00:23:58] And the downside risk is if the deal falls apart, the stock's going to fall back to its pre-deal announcement price, right? And so in entering deals after they've been announced, there's a very strong argument that you are bearing risk and therefore should get paid. And what you find over time is that if you look at the return stream of this type of strategy and its most generic beta implementation, you earn about 200 to 300 basis points above the risk-free rate.

[00:24:27] That excess return stream has a correlation to bonds that is near zero, has a correlation to equities of about 0.4 and has a correlation to the credit risk premium of only about 0.4. So it is an attractive diversifier. It's historically had a pretty decent sharp ratio around 0.4, 0.5. And so we think it's something that should be introduced in a portfolio. And there's a couple of merger ARB funds out there with which people could implement merger ARB. They just don't.

[00:24:57] I rarely, if ever, see it in a client portfolio. And so when we thought about interesting strategies to stack, we said, you know, merger ARB is at the top of the list. The question is, what do you stack it on top of? And what we wanted to do was stack it on top of bonds and position this as a potential corporate bond alternative, right?

[00:25:23] When you think of corporate bonds, investment-grade bonds, you can really decompose it into an implicitly stacked strategy. An investment-grade corporate bond is really nothing other than the duration matching treasury plus some credit premium. And if you isolate that credit premium, it's got a correlation to equities of about 0.6. It's got a correlation of bonds of slightly negative. You know, again, it's its own thing.

[00:25:51] And it's historically had a decent, you know, 0.3-sharp ratio type exposure. And so we said, well, what if we, in an environment like today where credit spreads are really tight, historically, active managers haven't necessarily outperformed generic beta corporate bonds. What if we were able to offer something where instead of implicitly stacking, we were explicitly stacking, where we're giving you US treasuries and stacking a merger ARB strategy on top.

[00:26:18] And what you get is a return profile that historically looks similar to corporate bonds, has a similar vol profile, a similar drawdown profile, but has less correlation to equities and less correlation to equities in the drawdown, and is uncorrelated to the existing corporate bonds someone might have in their portfolio. To us, that's a very easy way to say, hey, sell some of your corporate bond exposure,

[00:26:43] buy this stacked strategy, and you're getting this introduction of this novel risk premium. But the total composition of what you're putting into the portfolio, that bonds plus that novel risk premium, isn't moving your overall portfolio construction very far away from where you were, but you're getting the added benefits, added potential benefits of that diversification. So this is actually a fund we launched in December.

[00:27:09] It's the Return Stacked US Bonds and Merger Arbitrage ETF, RSBA. And it does exactly this. For every dollar you give us, we're going to give you a dollar of diversified US treasury exposure, plus a dollar of a merger ARB exposure stacked on top. And the ability to access that merger ARB portfolio, it's sort of a spy of merger ARB. It's an indexation approach. You're not doing research and saying this deal versus that deal.

[00:27:38] I'd just be curious, one, what's the vehicle through which you get that exposure? And then two, we know the S&P 500 is a cap-weighted index. How does the merger ARB index work with respect to kind of the relative sizing of each deal? So we actually do implement an active merger ARB strategy here. But I'm going to talk about the structure first, right?

[00:28:04] Because I think how we put this together is important. What we do is we get our bond exposure not by buying cash bonds, but by buying treasury futures. Right? And as you know, that requires very little margin outlay. So we can get a dollar of treasury futures with five cents of collateral. Now, obviously, we want to keep more of a liquidity buffer than just five cents, but the actual required margin is quite low.

[00:28:29] And then what we can do is for the merger ARB deals that are all cash deals, we can just buy the underlying stock. When they're mixed deals, cash plus the acquirer's equity, we can buy the underlying stock and short the prerequisite amount of beta of the acquirer. We can do that by going and taking the explicit short. We can go get it on swap if we need to.

[00:28:53] But the idea is, you know, we think of it as bonds plus the merger ARB stack on top. But to get the bonds, that's where we're using the capital efficient instruments like treasury futures to actually implement that. Now to your question about the strategy, right? The generic beta of merger ARB has historically been really attractive, in my opinion. 200 to 300 basis points annualized over the last 20, 25 years. But this is when you think about different deals, right?

[00:29:23] Think about a deal that has almost 100% certainty to completion. There's still going to be a spread, but that spread is purely going to represent just the time value of money at the risk free rate. And so if you take your portfolio capital and you invest in a deal like that, you're earning nothing but the risk free rate. And there is maybe perhaps the market's mispricing the tail risk that that deal falls apart.

[00:29:47] And so what discretionary merger ARB managers will do is they'll go through deal by deal and they'll try to qualify how likely the deal is to be completed, right? That probability of deal completion is a really important variable in estimating the expected return. Because you can observe in the market how much juice is left to squeeze in the spread. You can estimate pretty well how much downside risk there is.

[00:30:15] Once you then know the probability of completion, it's, you know, your expected return is the probability of completion times that upside spread minus one, you know, the probability of not completing times the loss, right? And there's your expected return right there. So estimating that probability of completion is really important. We partnered with a firm out of Israel called Alpha Beta. They've been running a hedge fund strategy of implementing merger ARB.

[00:30:43] We worked with them to turn that into an index. And so then we run their index methodology and we try to replicate their index within the ETF. Now, that index is an active systematic strategy. And they use a machine learning based model to try to go through every single deal and estimate that probability of completion. And they're looking at things like what sector is the deal happening in?

[00:31:11] The quality of the acquirer, right? That's really important. They're looking at the company getting acquired. They're looking at, you know, what sort of shareholder vote is necessary for the deal to go through. They're looking at all these types of qualification parameters and turning it into, at the end of the day, what comes out is what probability do they think the deal is going to be completed?

[00:31:34] And then you can effectively sort deals by their expected return and try to buy those deals with the highest expected returns or at least overcome a hurdle rate, which for them is SOFR plus 400 basis points. Otherwise, if we don't find any attractive deals, we'd rather just sit with dry capital rather than try to do deals just for the sake of doing deals where we think there's more downside risk. Right. And as you say that, I'll date myself here. I'll reveal my age.

[00:32:03] But I was half as old as I am now. It's 1997. I was covering long-term capital. And, you know, they had run out of things to do in core specialties like fixed income ARB and swap spreads and so forth and became really the 800-pound gorilla in risk ARB. Took a indexed approach, effectively just did every deal with the idea that there was risk premium on the table.

[00:32:29] But in the process of interacting with the market, and I think they did the same thing in swaps, and I think they did the same thing in long-dated equity vol, their presence in the market mattered. So, you know, they drove the implied rates of return lower and lower. And, you know, that's kind of where I wanted to go is, you know, your white paper compares risk ARB to credit spreads. You mentioned credit spreads have been tight.

[00:32:58] You know, compensation for bearing credit risk by the count of many has been not all that attractive for a period of time. So we know that these risk premiums, there's time variation in them. And I'm just sort of wondering, I think you kind of alluded to it there, to the extent that that 200 or 300 basis points that you're seeking in this risk ARB portfolio, I don't know, becomes more like 100.

[00:33:26] What's the sort of game plan when you see the time variation become, you know, a less attractive forward-looking rate of return? So that's exactly what happened in Q1. You always hope to launch into an attractive and interesting market environment whenever you launch a strategy. We launched into a market that was one of the driest markets for M&A activity since 2020, right? And this was pre-tariff tantrum.

[00:33:55] This was in Q1 where we saw that if the M&A activity continued, you actually would have had less M&A activity in 2025 than you would have had during 2020 when there was a global pandemic, right? So that tells you how little M&A activity has been going on. Now, what did we do? There were still deals, but we passed on the majority of deals and held a huge amount of cash in the portfolio, quite frankly.

[00:34:24] And that served us quite well. It was quite boring. And most people looking at us and evaluating the portfolio said, hey, call us when there's more interesting things happening, right? But one of the things we've seen in this tariff tantrum is a lot of the deals we passed on are now starting to get attractive again because their spreads have blown out.

[00:34:45] And so it gives us the ability to wait and be patient and enter the deals when we think the compensation for the risk we're taking is actually there versus just having to take every deal that comes to market. When you have to take every deal that comes to market, you're playing the diversification game. We still want to be diversified, right? We're still trying to be thoughtful about position sizing and limits and liquidity and everything associated there.

[00:35:12] But at the end of the day, if something doesn't offer an attractive return profile, especially given the risk it has, we'd rather just sit on cash. And that's ultimately what we did. You know, I expect we'll be adding more deals into the portfolio come turn a month. And as more deals happen, they seem to be getting more attractive. The market's pricing in wider spreads, just given the uncertainty. So we'll see how the rest of the year progresses.

[00:35:39] Again, tied to the larger macroeconomic environment. As a quant, I don't profess to have great knowledge about the macro environment. But I know it's going to be interesting to see whether this ends up being a 2020-like year where there's just not a lot of deals happening because so many companies are struggling to make that reinvestment in such an uncertain economic environment.

[00:36:04] But the counter argument there is that if these tariffs stick, one of the ways companies can grow is through inorganic growth, right? Acquiring smaller companies that maybe can't navigate the tariffs. So you could actually see once there's certainty about how the economic landscape plays out, you could actually see a flurry of built-up M&A activity as smaller companies that need to become part of larger companies to survive get gobbled up.

[00:36:32] This last two months, we saw VIX in the 50s. Even IG credit spreads blew out. They were impervious to risk-offs in 2023 and 2024. You mentioned risk ARB spreads have widened. And I just thought it was interesting as I was reading your paper on comparing corporate bond risk premium to merger ARB risk premium. I was thinking back to a paper by a professor I had at the University of Chicago.

[00:37:01] Mark Mitchell wrote one of the seminal pieces on risk ARB. I think it was called the risk and return characteristics of risk ARB. He wrote that with Todd Polvino when they were at AQR. And basically was modeling risk ARB returns to being short a put option, right? We know that, like you said, you squeeze out a little bit of return for a deal that's been announced. But obviously, if it comes undone, you could have a big downside.

[00:37:30] So you're sort of short a put. And then Merton model thinking around corporate bond risk is, again, these sort of things tie back to Black Shoals. They tie back to volatility. I'd love for it just to learn a little bit more as you sort of think about a risk premium like corporate bonds and a risk premium like merger ARB. What's similar? What's different? You did explore that a little bit in your paper, but I'd love to hear more.

[00:37:56] There's a general perception that merger ARB and credit both share a very common tail risk with equities. And you do see, right, there is a non-zero correlation between the merger risk premium, the credit risk premium, and equities, and the merger risk premium and the credit risk premium between them.

[00:38:16] What you do tend to see, though, is that the credit risk premium tends to be more sensitive to equity market drawdowns than the merger risk premium is. And the generally accepted hypothesis there is that there's a common economic beta that exists that, right, you get these large economic cycles that impact corporate profitability everywhere.

[00:38:46] And that impacts the ability to repay debt, right? And it impacts bankruptcies. And so there's a much more common beta across all corporate bonds that is going to be intrinsically tied to what's effectively playing out in equity markets. You get those large equity market drawdowns during periods of economic dislocation.

[00:39:07] Merger arbitrage, on the other hand, while you would expect that the probability of deal completion may go down during economic dislocations and or just there might be fewer deals happening during recessions. Merger arbitrage, on the other hand, when you're talking about a basket of deals that are all very idiosyncratic in nature.

[00:39:32] And there is a huge amount of corporate law that unless regulators step in, once a deal is announced, it's very actually hard for a deal to come undone. Obviously, the two biggest ones are if the acquirer goes bankrupt themselves, right? You sort of saw that happen with maybe Porsche and VW in 2008, where Porsche was trying to acquire VW and at the end of the day, VW acquired Porsche. And then the other one ultimately being obviously regulators stepping in.

[00:40:02] The example I love to give here is Elon Musk in Twitter, right? Elon said he's going to acquire Twitter. You cannot ever convince me he truly intended that and yet ended up having to buy it because corporate law is so strong. It is very hard for a deal, once it's announced, to come undone.

[00:40:25] And so that amount of corporate protection, so again, so long as the acquiring company doesn't go bankrupt or the regulators don't interfere, makes merger risk much more resilient to the economic cycle, at least historically, than credit risk is.

[00:40:44] And so, again, when we think about trying to get access in our portfolio to as many .3, .4 sharp strategies as possible, ideally higher, but in what's realistic in the world of mutual funds and ETFs, merger ARB is an interesting one, particularly as something that you could take away from the credit risk premium because it's going to be less correlated to the core betas you already have. Well, as you've said, no pain, no premium except in private credit, of course, right? Yes.

[00:41:14] So your .3 sharps are not attractive to people in the world of private credit. I'm trying to find ways that I can only mark my ETFs once a month, maybe once a quarter. Yeah. Well, you and your firm are among the subset of firms that are bringing pretty sophisticated strategies and solutions to a landscape that has previously been very, very vanilla.

[00:41:42] You know, the SPY, you know, maybe EEM, so a little international exposure, but it's been very, very basic stuff. And, you know, I know there was a change in the ETF rules that really opened up the opportunities for innovation. I would just be interested to have you reflect on that broadly. There are, and we've talked about this before, lots of option embedded ETFs, buffered strategies.

[00:42:12] There are strategies that have QIS in them. I just mentioned private credit. Apollo's got that new vehicle. As someone that's in the space doing innovation yourself, give us the big picture of what you observe, you know, happening in the last couple of years. What's the good? What's the maybe stuff that we're supposed to, you know, maybe pull the brakes on? Well, maybe just for people who aren't super invested in the ETF landscape, I'll give a little context, right?

[00:42:42] Because there has been this proliferation of alternative strategies. It's not that they didn't exist in the past, but you've definitely seen more. And I think it's a confluence of multiple things coming together at the same time. One, right, you had a huge proliferation. I don't know why that word's so hard to say. Proliferation of liquid alternatives come out post-2008 and a huge amount of assets dedicated to them in the mutual fund space. And they ultimately just failed to deliver in the eyes of most investors, right?

[00:43:12] So part of this was there just wasn't appetite for this stuff. And that's one of the problems we ultimately were trying to solve with the return stacking structure was how do you get people the diversification that they intellectually know that they want and need, but are struggling to actually keep in the portfolio? Then you had some regulatory changes.

[00:43:31] So you had something called the ETF rule that made it a lot easier for boutiques to launch active strategies in a way that the larger players sort of have a little bit of stranglehold. I don't want to say innovation always comes from smaller players, but when it comes to stuff like this, you tend to see the innovation come from the smaller players because it might be too much brand risk for the bigger players to take on. And so the ETF rule made it easier for smaller players to launch active innovative strategies.

[00:44:01] I think that helps. Then you had what was called the 18F4 derivative rule. So prior to 18F4, there was really no clear regulatory guidance as to how derivatives could be used within a fund. There weren't like hard and fast leverage limits. They're just really, you just never knew when you were off sides. And so it made it hard to try to do a derivative based strategy at any sort of appealing volatility target.

[00:44:29] 18F4 laid out a very clear framework. It's a VAR based framework as to if you are using derivatives, whether that's options, future swaps, whatever it is, you have to have this VAR reporting part of your process. There's very strict guidelines as to how much VAR risk you can take on. You know, there's all sorts of reporting requirements.

[00:44:53] All of that made it incredibly clear to know when you are on the right side of the line from a regulatory perspective. And again, makes it very clear to people who want to launch ETFs what can and cannot be done. The final piece here is the market makers, right? When you talk about launching ETFs in particular, the market makers are such a huge part of that ecosystem.

[00:45:14] And so their willingness to make markets on a more complicated product, their ability to do that is really crucial as to whether any of this stuff can actually come to market. And so I think what's happened over time is that they are seeing the need, the want for these products to come to market and they've developed the ability to do it.

[00:45:39] It's a lot more complicated for them to make markets on a actively trading trend following strategy that's trading long and short futures markets every day in an ETF versus, you know, a very vanilla equity index rate that rebalances once a quarter. So, you know, there's a lot more hands on to that. And so their willingness to participate in that ecosystem is crucial. And I think they, you know, continue to innovate to be able to do that.

[00:46:08] I mean, that last point is not something I had really thought a lot about. You make the point a strong one. And as I just think about, of course, technology is just, of course, always, you know, becoming more and more a part of what we're able to do. You said willingness and ability. The ability part is still really interesting.

[00:46:30] You know, you mentioned a multi strat, sorry, you know, a trend following strategy across assets. And you've got to get a market maker that's got, you know, his or his or her hands on top of what the actual value of that portfolio is. How does that look through work where they have confidence to make a price, you know, real time? Yeah, I mean, you are typically disclosing your underlying basket to them so that they can.

[00:47:00] I mean, that's the that's the simple answer. And ideally, you're doing it as real time as possible. You know, if you're trading multiple times throughout the day, you're either disclosing that multiple times throughout the day to your market makers, or you're accepting that they're just going to put a much wider bid-ask spread and have much thinner markets. Around what you're trading and that's and that's a trade off you might make.

[00:47:28] But there's a reason why certain firms won't do the ETF vehicle and they'll stay in mutual fund only. It's because it to make the ETF work and make clients happy and know that they can execute with good liquidity. It requires a tremendous amount of transparency. And there are just certain strategies that are harder to implement in an ETF, right? If you're trading less liquid markets or markets where you might get front run or you're trading markets that might be hard to hedge, right? Markets that are closed.

[00:47:58] You know, if you're trading futures, not all these markets are open or liquid when the U.S. market is open or liquid. But that sort of stuff is actually better in a mutual fund than it is in an ETF. So just by comparison, we have a mutual fund that trades, I think it's 70 plus futures markets. And we trade markets all around the world and we trade agricultural products and stuff that's less liquid. We do that because we only have to strike NAB once a day and we don't have to disclose what we're doing.

[00:48:24] In the ETF, we trade 27 markets that are highly liquid. All of them trade at some point during U.S. hours, right? So we can execute with liquidity and the market makers can put their hedges on. And I think if we were to take the much more diversified approach, our bid S spread would be much wider. To the point about willingness, though, you know, when you come to market with an ETF, you have a lead market maker who's agreeing to make markets.

[00:48:55] Your goal is to attract more market makers, right? That's how you get a competitive market and you get your bid S spreads down. But it's a little bit of a chicken and egg. Like you need to get enough volume and assets and enough trading to convince those other market makers. It's worth taking the man hours and time to figure out how to build a hedging program to your product. And I've had market makers who started making markets on some of our products and then said, you want to know what?

[00:49:23] But we'll come back when there's more volume because we just it's not worth the man hours given how many other ETFs are coming to market that are easier to hedge. And this is, I think, actually. A whispered problem in the industry right now is there might be too few market makers for the number of ETFs that are coming to market. And you're hearing of more ETFs that are struggling to find a lead market maker when they're trying to launch, particularly the more complicated ones.

[00:49:52] It seems to me that a lot of what you are thinking about and trying to solve for is this elusive thing called diversification. And, you know, it's rare, I think, amidst some crisis event where someone looks at their portfolio and says, gee whiz, you know, I'm getting more diversification than I expected. Right. It's almost never the case. Some assets can be really good diversifiers for periods of time. And, you know, that can change.

[00:50:21] I think gold is one of those. As I always say, you just can't count on its anti correlation to the S&P. You know, it's a different asset, but it's not as if it's a hedge. You're not buying a put option. You've done a ton of work on trend strategies. And to me, that's a trading strategy. It's almost asset agnostic.

[00:50:45] And I just would be curious if you could just talk about as you think about new products or things that are in the lab that you can share in this in the spirit of this. And I just want to say, well, you know, it's a big deal.