Salem Abraham, Abraham Trading Company - Managing Risk Starts With Imagining the Unimaginable | #282

Episode Summary

Executive Summary: Salem Abraham, president of Abraham Trading Company, shares his journey from meeting turtle trader Jerry Parker to building a successful trend-following CTA. He emphasizes risk management, diversification, and preparing for extreme events. He discusses his Fortress Fund, which allocates to stocks, bonds, gold, and carefully selected hedge funds to provide a storm-proof portfolio. He also shares personal trading stories and views on fiat currency, Bitcoin, and real assets.

Main Topics: Origin Story and Meeting Jerry Parker (Priority: 5/5): Salem recounts how he met Jerry Parker at a family gathering, leading to an invitation to learn about systematic trading. This encounter set him on a path to trend following and quantitative trading. Trend Following Philosophy and Risk Management (Priority: 5/5): Salem explains the core principles of trend following, the importance of risk management, and the need to prepare for extreme events like the 1987 crash. He stresses that the unthinkable can happen and must be accounted for. Evolution of Trading: From CTA to High-Frequency Trading to Fortress Fund (Priority: 4/5): Salem describes his career progression from a traditional CTA to pioneering electronic trading and high-frequency arbitrage, and finally to managing the Fortress Fund, a multi-asset portfolio. Importance of Diversification and Non-Correlated Assets (Priority: 5/5): Salem argues that true diversification requires assets that are not correlated to equities. He criticizes many hedge funds for being equity-like and advocates for including CTAs, currency traders, gold, and real assets. Views on Fiat Money, Bitcoin, and Real Assets (Priority: 4/5): Salem expresses skepticism about fiat currencies and Bitcoin, preferring real assets like land, gold, and productive businesses. He warns that printing money usually ends badly. The Fortress Fund Strategy and Allocation (Priority: 4/5): Salem details the Fortress Fund's allocation: 45% equities, 20% treasuries, 35% hedge funds and gold. The fund aims for safety and diversification, with a focus on hedge funds that do not add equity beta. Memorable Trades and Lessons (Priority: 3/5): Salem shares notable trades, including the COVID-19 put trade that returned 30x in 37 days, and the CME seats trade. He emphasizes the importance of sizing and knowing when to exit.

Key Arguments: Risk management is paramount; always prepare for extreme events (e.g., 37 standard deviation moves). Diversification across asset classes and strategies is crucial; avoid over-concentration in equities. Hedge funds are often mislabeled; many are highly correlated to stocks; seek truly diversifying ones. Fiat money printing ends badly; own real assets like land, gold, and productive assets. Trend following works over long term but can have long drawdowns; investors should not chase past performance. Investors should be the lifeboat, not tied to the main ship; endowments need to be resilient in crises.

Data Points: Standard deviation move in Eurodollar futures: 37 - On October 20, 1987, the day after the crash, there was a 37 standard deviation move in Eurodollar futures, which Salem was on the wrong side of. Initial trading account size: $100,000 - Salem started trading in January 1988 with a $100,000 account from family, with a rule to stop if half was lost. Peak assets under management: $600 million - Salem's CTA managed over $600 million at its peak in 2011. Average annual return over 31.5 years: 13.1% - The CTA returned 13.1% net to clients over 31.5 years, though the last 10 years were flat. Fortress Fund maximum drawdown in March 2020: 1.5% - During the COVID crash, the Fortress Fund was down only 1.5% at its worst, and ended the year up about 12%. COVID trade return: 30x in 37 days - Salem turned $200,000 into $6 million by buying puts on United Airlines and Carnival Cruise Line. Farmland loss rate: 4.8 acres per minute - Between 1997 and 2022, approximately 4.8 acres of cropland were lost per minute to urbanization (from the ad).

Pivotal Quotes: "The unthinkable can happen." — Salem Abraham: Discussing the 1987 crash and the need to prepare for extreme events in risk management. "You've got to be the lifeboat. Don't nail yourself to the main ship so you go down with the ship." — Salem Abraham: On the importance of endowments and portfolios being resilient and not overly correlated to the economy. "Numbers won't lie to you, and history doesn't lie to you. Be open to the extremes because they happen." — Salem Abraham: Closing advice to listeners about using data and history to prepare for tail risks.

Implications: Investors should prioritize risk management, diversify beyond stocks and bonds, and consider alternative assets like trend-following CTAs and real assets. The Fortress Fund model demonstrates a storm-proof portfolio that can withstand crises. Fiat currency risks suggest holding tangible assets.