Jerry Prior, Mount Lucas

Frank and Tim did. They spun out, they spun out Mount Lucas. And, away we went and got ourselves into the managed futures business, managing institutional asset classes and doing that ever since. We also do global macro as a firm. And then, launched, took, took the, the managed futures product sort of outside the SMA and the hedge fund world into the ETF world back in 2020. And, and been running, running that pretty successfully. I think there was some pretty, pretty significant market environments during that period. Yeah. We're going to, I definitely want to dive deeper into KMLM, which is kind of the main focus of today. But I also want to talk a little bit more about Mount Lucas, but before I do outside of

Work, what do you like to do when you're not trading commodities? Well, I've got three kids, all college age and above. So that's, that's been a certainly, certainly a ride. All three of them played sports in college. I had a rower at a, my, my daughter is a basketball player at Fairfield and my youngest is a baseball player at Virginia. So that's, that's been quite a ride. And myself, I played tennis in college. Don't play a lot of tennis anymore, but do a lot of platform tennis. So for the few people in the Northeast that know what that is, it's a sort of outdoor tennis. You can play in the winter up on a platform with chicken wire cages around you. So it's a, that's where I spend most of my free time doing that.

Yeah. I, um, I played for a year. I'm in the Northeast as well. I'm in Pittsburgh. So I played for about a year, maybe two. And when I saw one of my best friends popping Achilles, I was like, I think I'm done with platform tennis. Yeah. Sort of like pickle. It's an orthopedic, uh, orthopedist dream, it's, it's like as many people as can play, keeps all, keeps them all on business. Yeah, it is fun, but I'm not taking the risk. I've got too much to do. I have two young kids and I'm chasing them around. It's a, with a pop to Achilles doesn't seem fun, but anyways, back to business. You mentioned a little bit, um, Mount Lucas, it was, it was founded in 1986.

In 1988, they actually created the MLM index. So that really is a big part of the origin story where this is kind of the first passive index measuring the returns of future invest, of futures investing. So that index is largely from what I have read is remain unchanged for almost 40 years in an industry obsessed with new models and constant optimization. And so what's the case for a strategy that stood the test of time without being tinkered with after all these years? Yeah. So I, I think that goes back to, the, or the origin, uh, of the MLM index in 1988, uh, as I said, with Eastman Kodak's plan to come, um, to us and we were running, a rate, a range of managed features models back then. Um, and sort of what, what happened

Was we started running money for Kodak in late 87, uh, clearly a bad, bad environment for stocks. Uh, we did well, they were happy. They, their chief investment officer had come down for a site visit the following quarter and asked, I think two important questions that sort of set the DNA of the firm. Uh, the first being like, managed futures did well. You said, you said this was going to be defensive and risk mitigating type of strategy. Uh, but why, why did it work? Uh, what's the wind behind the sales, uh, in managed futures? Is there an invest, is there a durable investor risk premium there? Second question he asked, he says, uh, I know you guys did well, but I don't know on a relative basis how well you did. Like, is there, is there a passive

Benchmark to the space that, uh, that I can compare you to? And, at the time there were manager based benchmarks, which are the average or whatever the managers were, but there was no sort of price based benchmark like the S&P 500 is, uh, to stocks or Dow Jones's stocks. So, um, for us in the eighties, wild, a bit of the wild west and managed futures early on in the asset class, uh, for, uh, my, my partner, Tim always says, I had to look bench benchmark up in the dictionary. we were traders, uh, we either, we either made money on a trade or we lost money

In trade. The benchmark was zero either, you either made money or you lost money. So, but it got, it got us thinking about, um, is there an investor risk premium here? Is it durable? Why does it exist? How does it exist? And, and to answer that question, we thought, we thought about why, uh, why futures markets exist at all and futures markets in why, how they're different than equity markets. So futures markets are, um, well, if you think about equity and credit markets, they're all part of the capital structuring, uh, of businesses, businesses and companies want to build and grow. They look to investors for capital, uh, and those investors seek to earn a risk premium associated with capital appreciation, uh, earnings

Growth, dividend growth, all, all the things people have been doing for hundreds of years, sort of investing in, in the global growth, global growth of the world of the world, uh, and economies. Um, and everybody should, and everybody should be doing those things, but futures markets exist because those same businesses and companies, once they're up and running face real operational risk around, around prices, around whether they're changes in interest rates, changes in commodity prices, whether input or output, uh, changes in FX rates, if they're selling goods internet, uh, internationally, the changes in price. If you're a corn farmer and, in, in, in price, uh, corn, uh, dramatically drops between the time you plan it and the time you harvest it and sell it, uh, face real risks, uh, to their margins, to their businesses, uh, and up and

Have ongoing operating concerns. So futures markets exist, give them the ability to go, uh, into those markets, hedge away that price risk, uh, that they face, that they have no control over a lot. It gives their businesses price certainty, uh, and an ability to concentrate around their businesses as efficiently as possible without worrying about, uh, exogenous risk where we step in, uh, on the investor side, the managed future side in the futures business. Uh, we're taking the, uh, we're taking the other side of that risk transfer. We're systematically owning, uh, price risks through time. That's the function we play in the futures markets. We're a $350 billion asset class. So we're, we're, it's a very sizable asset class and we participate in the price discovery and, and the accepting of that risk

Through time from companies that need price certainty. We're willing to accept that price uncertainty. And then the, the next question is, and well, how did, what does that mean? You systematically accept price risk through time? Well, how, how does that work? Um, how, how, how does one go about earning that risk premium? And, uh, quite simply the, probably the, the simplest, most efficient way, uh, of doing that accepting price risk through time is through trend following. It's what not, I would say 80 to 90% of our asset class, how, how they, uh, managed futures is, is predominantly 80, 90%, uh, systematic. Everybody's doing a trend following in some, in some sort of way. There's a lot of different ways to do it, but at, at, at the very, if I was to leave this conversation with

Anything, we are getting at, uh, we are participating in an economic risk transfer. There is a premium there that exists and it exists. And if you think about how, when that, when that premium is, uh, most impactful, it's when markets get really volatile, uh, prices are disrupting, uh, moving from one level to another periods like inflation, deflation. Uh, those are all strong, uh, strong markets for us. Recessions that create deflation, all, all the sort of crisis stress type events that equity markets and long only portfolios hate, uh, we tend to thrive in because that's when prices are getting disrupted and there's a lot of price risks that we're, we're, we are owning, uh, during those periods of time where our, where trend following doesn't work. Uh, it's sort of now it's, it's,

It's the, it's the flip side of that stable markets market, zero interest rate, uh, world markets aren't moving around a lot. Um, there's not a lot of trends, trends there, but that also sort of makes sense. If you think about the, um, the risk transfer price going up, risk transfer going on under the hood in the futures markets, because, business and companies, they have price certainty prices are stable. Um, there's just not, there's not a lot of risk premium in, in, in, when prices are stable in the futures market. So why managed futures works in portfolios is because we do well when things are going really bad, when things are stable and equity markets are just marching on up, um, where the, where prices are really stable.

Uh, we don't, we don't do as well. So at the end of the day, we're diversifying, we're uncorrelated to stocks and bonds, uh, and then tend to get pretty negatively correlated every time there's some sort of stress event like 2008 or after the tech bubble, 2022 was one of our best, best years in the industry. Uh, and even early this, early this year, uh, the ability to be long commodities was, uh, really impactful to both our strategy and our impact to end client portfolios. Yeah, I definitely want to talk about some of those areas because manage, managed futures, in my opinion, are always something that, should be owned.

And then advisors end up selling at the wrong time because they're a return drag. And in reality, they need them there when markets get, when markets get pretty volatile, or as you mentioned, a serious situation like 2022 where nothing really worked, um, other than managed futures. So let's talk about KMLM though. It's the crane shares, Mount Lucas managed futures index strategy ETF. You guys launched this back in 2020. What is this fund actually doing? You just did a great example of how managed futures work, but what should somebody expect inside this fund? Yeah. So, uh, the fund is replicating, uh, the index we built back in 1988. Uh, so it is trend following 22 futures markets. So it's some of the largest, most liquid markets, uh, in the world.

Um, one thing we always talk about in managed futures is the ability to do well during periods of stress and periods of, uh, crisis. The nice thing about these markets are exchange traded. They're very, very deep. They're very liquid, uh, in a, in the fixed income space where you're talking about trading in the U S 10 year or the UK, uh, long guilt or the Japanese government bond or the Canadian government bond, deeply liquid markets in the currency space. It's the yen, it's a Euro. Um, it's a Canadian dollar, Australian dollar in the commodity space. It's crude, gold, um, natural gas, heating oil, uh, grain markets like beans. We deeply, deeply liquid markets. And, and in periods of crisis that liquidity holds up, uh, I tell people our strategy,

It tends to get more liquid during periods of stress, not less liquid and not a lot of alternatives and not a lot of, um, particularly, particularly things with, with, with privates, uh, or, um, uh, illiquid assets underneath the ETF, not, not a lot of alternative strategies can, can say they're that liquid. And, um, so we have the liquidity in KMLM as the liquidity in the ETF, but it also has the underlying liquidity of markets that tend to tend to, um, get, as I said, get more liquid in those periods of stress. Cause a lot of them are used to safe haven type of assets and it's where assets are flowing. Uh, anytime you see periods of stress, you see, you see it expressed in bond markets and you see it expressed in currency markets

And you see it expressed, uh, in commodity markets. And, and that liquidity is important, particularly for a diversifying strategy, uh, because, uh, the one, the one thing, uh, what you need out of your diversifying strategy is, is liquidity and ability to harvest and monetize that diversification, uh, when you need it most. And, in a period like 2022, uh, where, we're up a lot or 2008, where we're up a lot and equity markets are, in 2022 bond markets were also struggling. Uh, it's great that we're up a lot, but if, if you can't use that diversification, we're providing you in the moment and, sell some of us rebalance back into your stock and bond portfolios, you're sort of missing the point, if I'm in, I think, you know,

This is something I've started to say a lot recently is that, advisors, uh, and investors need to start thinking about liquidity as, uh, and, and rebalancing as the, as alpha. Uh, a lot of people look for managers to provide alpha in their particular strategy, but, but that liquidity, uh, in a diversifying strategy is alpha to the advisor. It's the ability to take the, the thing you're using for defense and turn it into offense at the moment you need it, at the moment you need it the most. So, it's a hard thing, when we get, with our institutional clients, when we've been most successful, we've seen sort of our largest redemptions, uh, because it's, it's them saying, Hey, thank you very much. I need to make,

Uh, payments to my beneficiaries or I need, or this is great. Um, I see stocks on sale. I can get them for, uh, stocks on discount. Uh, I'm going to take your gains. I'm going to rebalance that back into my equity portfolio. And then, and then you get the real sort of, the miracle of compounding effective, a smoother ride compounding on a higher number. Uh, that's, that's the real alpha, uh, advisors, uh, can add is liquidity plus diversification, uh, allows you to monetize it, monetize it at the right times. So when I was looking through the portfolios, you just mentioned, it's like 22 different futures contracts, commodities, currencies, global bond. But one thing that stood out to me is there is

No equity exposure. I think a lot of your competitors include stock index futures. Why is index future equity index futures deliberately left out? So, yeah. So, that goes back to the original construction, uh, right back in 1988, equity index futures weren't really a large thing. they were probably S&P index futures, but they, they didn't have futures on a lot of the, uh, country equity index markets. That's proliferated a lot, uh, over the years. And I think, we've always, the consideration to add them has always been there, uh, as far as the, our index committee, uh, cause we look, we look at the constituents every single year and decide what we want to add or not. But I, but the, the feeling of the firm was that

Is, is, uh, understanding why managed futures is used in a portfolio to, to us, uh, trend following, it's not that trend following equity doesn't work. It tends to work really well and it, or not tends to work well, uh, particularly in periods of bull equity markets. So it helps managed futures do a little bit better during bull markets, but it does that at the cost of providing less protection, uh, when needed most. And having equities, uh, tends to muddy the diversification benefit. No, if I were to own managed futures and that was the only investment, uh, in my portfolio, I'd probably put equity, I'd probably trend follow equities, but that's not what, that's not the portfolios that people have. People already own equities. There are better ways

To own equities than trend following. And what may, what they're coming to us for is, is for diversification. And by me adding equities and adding to the end client, uh, portfolios, equities, I'm muddying up that diversification benefit. So what we wanted to do was keep our, our strategy pure, uh, so that it, so that it could maximize, uh, diversification benefit when it, when it's needed most as opposed. And, and again, it's, it's a decision to say, Hey, maybe we're going to give up a little bit, uh, we're gonna have a little bit lower average return than maybe somebody that is including equities, but in the moments that you need us the most in the moment, in the moments that you hired us for, uh, we think, we think our construction, uh, is going to do a better job

At diversifying at the most important times. So I know this is going to go back to original index construction, but this is one of the more unique, um, I would say waiting structures I've seen in, in all the ETFs I've talked with, it's based on relative volatility. So you're waiting these, uh, futures based on their relative volatility. I'm assuming that relative volatility over time changes and therefore weightings change. So can you kind of walk us through that process and how often you're kind of looking at relative volatility in order to adjust the weightings of the portfolio? Yes. So when we, we launched the index back in 1988, we were, we were actually, I believe back then it was 25 markets and we equally weighted them. And, um, and that was sort of okay. Cause it, you know,

It, we, of those 25, I think 16 were commodity. And the thing with commodity markets is they're a lot more volatile than bond or currency markets. And, and what ended up happening, it was, it, it was really a commodity, uh, from a risk standpoint, it was really a commodity, uh, dominated index. And, and again, at the time I was okay, because most, most of the managed future space was, it was primarily a commodity, uh, investment. Uh, but as markets evolved over the nineties and two thousands, currency markets and bond markets became much more, uh, important in this space. Uh, and in 2005, we went to this sector waiting where we, as we allocated exposure, we gave 42 and a half percent to bonds, 32 and a half percent to currencies and, uh, 25% to

Commodities that, um, and the, in the reason, and the reason we did that was, it's, it's relatively simple, uh, bonds got the most exposure cause they're the least volatile currencies in the middle commodities got the least exposure cause they're the most volatile. The idea being that through, through time, uh, each sector, so bonds, currencies, these commodities would have an equal contribution to risk through market cycles. Now we haven't changed. Uh, we look at those weightings every year, uh, with a, with an index committee, uh, but we haven't changed them since 2005. And it's not because volatility of those markets hasn't changed. We certainly saw bond volatility, uh, dropped, uh, very low, uh, in the, in the teens, but, in the, in the sort of the answer to that would have been to, to increase exposure,

Uh, even more dramatically in, in the bond space. And, our feeling is, uh, we value being, uh, roughly right on these weights, uh, instead of precisely wrong. Uh, I would say a lot of what goes on in managed futures, the way they size positions, um, they're usually looking to achieve a constant, uh, vol target among all the constituents that they trade in. So they're constantly looking at past volatility to, in order to size each one of their positions so that each, each individual market is providing the same, um, risk contribution to the fund. We think, uh, we think that approach, uh, again, it's another one of these things that is fine. Uh, but, but it's counter to what drives returns at trend following. So if you think, so the technique, a lot, a lot of firms use is called

Vol scaling. And, and basically what it means is if, uh, if the volatility, uh, of a particular market is falling, uh, they take more exposure. And if the volatility of a market is expanding or rising, uh, they, they reduce exposure. And if you go back to why, how I talked about the risk transfer in the space and when trend following works, well, we work best when markets are more volatile, uh, and, and we think we should be holding onto positions in a more volatile market because that's when it's working. That's when there's profit in the positions. And, and we got to let that profit run because that's how we provide diversification to equity and bond portfolios. What happens if you're vol scaling is you get into a market crisis and vol is expanding across all markets. And then if you have a managed

Teachers guy that's reducing exposure into that vol expansion, he's sort of, he's monetizing his gains, which is great, but he's reducing his diversification potential to, to the in client portfolio. So the manager is sort of getting the, all the benefit of that, that, that, uh, exposure reduction, but not, but you're not getting the benefit in your, in client portfolio because the way really you want to own that as an advisor, uh, in, in, in, in, in your asset allocation is like, you want us to get all the gains that we can so that you can monetize those and pour them back into your stocks, not me monetize them inside my portfolio. And ultimately that's what, that's what, that's what happens with vol targeting. It's not, um, it's not, it's not wrong. It's not a bad

Practice. It does, it does work and improve sharp ratios of strategies in our space, but it, but it, it, it does do it at a cost and the, and the cost is, uh, and it is, is in the diversification potential. So, so we kind of already talked about the power of the portfolio, like in 2022 stocks and bonds fell together. People were questioning the 60, 40, you guys were up, somewhere in the 30% range. Um, and that, that is kind of like the real pitch for managed futures. And we also already kind of touched on how that uncorrelated return stream can really help balance out returns and help, compounding over a lower, a higher base over time to make

It more attractive. But in reality, the way that you can provide that is that this portfolio can go long or short across all of these markets. So you're not relying on just prices going up to make money. So can you walk us through how the short side works and why that matters so much? Yeah. So, just to back up from a high level, all trend following is, is, uh, in the way our index approaches it, it's, it's, it's really, given that we're an index, it's pretty straightforward. If a market's going up, we get long. If a market's going down, we get short. We use a long-term moving average, uh, one year moving average. If prices above it were long prices above below it, we're short. We look at it every single

Day, rinse, repeat, do it over and over again. So, um, but what the, what managed futures does, um, it gives you optionality to a wider range of market events by being able to go short things and being able to be long things. So in 2022, uh, we, we came into the year long commodity markets. They, they had already started a lot of markets had already started to, uh, move higher. And when the Ukraine war started, you create, you created shortages in wheat, which bled into the other grain markets and you get shortages in natural gas. Uh, and then, plus, plus oil markets got, got, it got ripping all those things. We, we came into, we came into 2022 with, with the exact right positions on, in commodities. And we actually came

Into the year, largely short bond markets. And, for the first five months of the year, that commodity, that commodity trade dominated our results. And, um, and then they, and then commodity markets started to stabilize a bit. And then, and then we saw, and then the world said, Hey, wait, these higher commodity prices, these higher energy prices are going to bleed into inflation. Um, what's the fed going to do? Uh, and then all of a sudden we saw bonds sell off pretty aggressively, uh, through the end of the third quarter. And, um, we sort of got that end of the third quarter gift from, uh, Liz Trostover in the U or Liz in the UK with the, um, that really drove the, the, the, the guilt market crazy over

There, but that's, that's in the weeds a bit, but the, the ability to be long or short arrange, arrange in these asset classes is, is really powerful in 2008, being short, uh, commodity markets and being long bonds was the right place to be 2022. It's the opposite long commodities, short bonds, uh, in a world, uh, in a 60, 40 world that can't depend on bonds, stabilizing equity drawdowns anymore. any cons, if the fed, uh, or the world has any concern about inflation or inflation is top of mind, bonds just can't deliver that, the kind of protection they did for the 40 years, previous to, um, pre previous to, uh, 2020. Again, we've been in this business a long time, going back into the

Eighties and the founders back into the seventies, they remembered that managed features, uh, work during periods of inflation and then nobody saw it for four decades. And, um, so it wasn't as surprised to us, uh, given our firm history and DNA that it would work again. Uh, it's, managed features kind of got thrown into this crisis, uh, risk, uh, type of thing that'll work if there's a big recession. Well, Hey, we also work when in periods of inflation, we don't, we don't just need prices to move one way. We can work, uh, uh, in different types of environments, inflation being one of them.

And, and in all reality in 2022, or even so far this year, which, markets are trying to seem to be trying to front front run a 2022 trade again because of the Iran war and the downstream effects that I'll have on inflation. Um, that, again, there is no other asset class out there that can get you as short as bonds as we can. Uh, in 2022 tips, gold, all the normal inflation things didn't really, didn't really work. And, um, but being able to be long commodities, short bonds did work, uh, in a significant period of inflation. And again, again, it started working, uh, decently this year as well. So Jerry, we're up, we're coming up on time, but I have to ask, you know,

One more question. Um, the fund pays a meaningful annual dividend or distribution. Where does that come from and how should investors kind of think about this annual distribution? Yeah. So, those aren't, uh, those, it's not a return of capital for sure. Uh, it's a, it's a return of gains as sort of required by, '40 Act rules. Um, so in a, in a year where we make money, we'll, we will have to distribute the gains in the fund. Um, the futures, at least the currency, currency in the bond futures, uh, they earn, uh, so the way futures markets work is they get, they get, uh, 1256 tax treatment, which basically means they get marked no matter what at the end of the year. Uh, and 60% of the gains get treated as long-term and 40%

Get treated as short-term. Uh, the commodity markets, uh, exist in a, in a Cayman structure and those positions exist in a Cayman structure and get passed through as ordinary gains. So the way I think people should think about it is if the funds up a lot during the year, they should expect a dividend. If it's down, uh, they should not expect the dividend. Perfect. Well, Jerry, I really appreciate you spending some time with me today. Before I let you go, where can people learn more about Mount Lucas and get all the information they need on KL, KMLM? Sure. So Mount Lucas, uh, you can follow us on our, on our, our website, www.mountlucas.com. Uh, you can also find us on, uh, LinkedIn and X, uh, as well as the fund website, which is, uh,

Crane shares.com. Great. Well again, Jerry, thanks for hanging out with me today. Yeah. Thanks for having me, Brad. Yeah.