Risk-on/risk-off (RORO) describes how investors flip-flop between riskier investments, such as stocks, which can offer higher returns (risk-on), and lower-risk investments, like bonds, which historically yield lower returns (risk-off).
The New York City-based portfolio manager Michael Gayed joined Opto Session’s co-host, Haydn Brain, for a live conversation on Twitter Space. Gayed runs three funds for Tidal [TIDAL], owner of the ETF management brand Toroso Investments, all three of which have been established since 2020 and rely on treasuries.
Markets reflect people
“I think markets are a reflection of people,” says Gayed: “If markets are broken, it's really people that are broken.”
According to the investment manager, the cause of this dynamic is that investors increasingly fail to understand the significant benefits a long-term horizon offers.
In a world where social media is ubiquitous and attention spans are ever-shorter, Gayed thinks markets suffer because people tend to trade more off noise than signal.
“I think a lot of people have lost the very notion of what an investment is supposed to be,” he says.
Back to RORO?
Gayed thinks that we have already returned to a RORO dynamic.
The spark for this came on 16 November, five days after cryptocurrency exchange FTX filed for bankruptcy, marking a downturn in the market.
“I think something major happened on November 16... For all we know, there could be a lag from what we're seeing in the cryptocurrency space. The collapse the liquidity, the deleveraging to stocks.
“Now, I'm not making the argument that it's going to be like 2008, but in a highly levered system, a butterfly flapping its wings can create a hurricane.”
Gayed highlights that what he witnessed on 16 November resembled “a fear trade, a flight to safety trade,” and he thinks it was an indication that there might be a change in the correlation between treasuries losing money and equities losing money.
“I hope it persists,” says the investor, adding that “we'll know with hindsight, but if there is some kind of a tail event that might be looming with a delay on risk assets, we may end up looking back and saying, treasuries actually saw it first.”
A rules-based approach to investing
“I believe that being systematic, rules-based, is probably much better — as long as you can point to cause and effect — than purely discretionary trading. That's not to say there aren't great discretionary traders, but at least when it’s rules-based and systematic, it's repeatable.”
The three funds that Gayed runs for Tidal are the ATAC US Rotation ETF [RORO], the ATAC Credit Rotation ETF [JOJO], and the ATACX Rotation Fund [ATACX], all active since 2020 and devised according to the concept that treasuries act as a safe haven, being the longest risk-off asset that benefits from stock market volatility.
According to Gayed’s market insights channel, The Lead-Lag Report, his approach is based on “time-tested strategies, resulting from his market anomalies research,” while also being “designed specifically to seek higher returns while minimising risks over the long-term.”
Gayed tracks what he thinks are essential signals to help him determine market conditions. In particular, he watches the behaviour of utilities related to treasuries, and the price of lumber related to gold, two seemingly unrelated commodities that, according to Gayed, serve as significant volatility indicators. He has co-authored five award-winning research papers documenting how these signals can be used to manage investment portfolios.
Treasury anomalies’ link to the Fed rate hike
“The narrative that the Fed hiking rates is what broke treasuries is just not true historically,” reckons Gayed.
On 27 November, the investor posted a Twitter thread with data and graphs showing that in major drawdowns during significant high-volatility periods of the past, treasuries more often than not acted as the counter asset. However, this has not been the case for 2022.
“The best way to play high volatility in equities is treasuries, except this year. And my approach is purely rules-based... This is the only year in history where treasuries have lost more than equities in a massive drawdown,” remarks Gayed in the interview with Opto Sessions, admitting that 2022 has been “hell” for him.
The investor thinks the drawdown in treasury prices started in late July or early August 2020 — in other words, significantly before the moment when the Fed started hiking rates.
Gayed says that “you have to look at history, and the reality is it's not just as simple as saying the short-end rises, the long-end rises as well.”
As Gayed’s research recognition grew, so did his Twitter audience, which currently comprises over 727,000 followers. However, a few users have gone to the platform to express criticism towards his investing approach, in light of his funds’ recent poor performance. Gayed believes this criticism partially originates from people’ recency bias, a cognitive bias that favours recent events over historic ones.
“It's funny because seemingly people forgot that in 2020 my mutual fund was up 72%,” says Gayed, remarking on the “anomaly” experienced in 2022, with the ATACX Rotation Fund being down 22.5% year-to-date, and up 3.75% in the past month.
Gayed highlights that the concept behind his investment funds is “purposeful, quant-oriented” and should “live beyond him” as their portfolio manager.
“Recency bias is making everyone on FinTwit think treasuries will never act as the safe haven again. We don’t know if the drawdown in stocks is over, which means the historical risk-off dynamic can come back,” says Gayed.
Grit is key
According to Gayed, if there's one word that describes what sets great investors apart, it’s grit.
“Every single great investor has periods where they have severe dislocations, severe drawdowns... Nobody ever says he's a horrible investor because he lost 50%. The thing that really separates the good from the great are those that have drawdowns, but keep going,” he explains.
The foundations of Gayed’s investing strategy come from a book titled Intermarket Analysis and Investing written in 1990 by his late father, Michael E.S. Gayed, who worked alongside investing legend Bob Farrell, a top Wall Street strategist known for predicting changes in stock market direction.
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