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Speaker 1: Hi, all Thoughts listeners. Joe and I are working our

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Speaker 1: way through a pretty big backlog of episodes. So what

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Speaker 1: that means is what you are about to hear is

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Speaker 1: something that was reported quite a while ago. We recorded

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Speaker 1: this one back on March three. We were in the

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Speaker 1: midst of the big market crash back then, but we

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Speaker 1: hadn't really seen the effects of that crash work their

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Speaker 1: way through the financial system. So you're gonna hear Joe

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Speaker 1: and I talk a lot about how weird it is

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Speaker 1: that we haven't seen any big trading blow ups just yet.

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Speaker 1: Of course, since March we have had a few, notably

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Speaker 1: a big oil fund in Singapore and also a hedge

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Speaker 1: fund called Malachite in New York. I think, if anything,

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Speaker 1: it makes the episode more interesting and the themes discussed

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Speaker 1: probably more estion. So I hope you enjoyed. Thanks for listening. Hello,

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Speaker 1: and welcome to another episode of the All Thoughts podcast.

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Speaker 1: I'm Tracy Allaway and I'm Joe. WI isn't all so, Joe?

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Speaker 1: You know what I've been thinking about quite a lot recently. Um, Well,

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Speaker 1: I don't know. Is it the same thing that literally

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Speaker 1: everyone across the entire world can't stop thinking about and

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Speaker 1: dreaming about and talking about or is there something else

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Speaker 1: going on? Wait? Are you thinking of the virus or

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Speaker 1: the market sell off? I think I've been exposed to

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Speaker 1: financial markets for too long because they're sort of both

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Speaker 1: entwined in my mind. I literally like dreamed last night

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Speaker 1: about both the virus and the market crash, and I

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Speaker 1: have not thought about anything else. So, but now, what

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Speaker 1: is the specific thing that you yourself are thinking about

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Speaker 1: these days? Okay, it's kind of an offshoot of the

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Speaker 1: market crash, and it's basically, uh, investor blow ups, So okay,

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Speaker 1: that's that's timely. Yeah. So one of the interesting things

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Speaker 1: about this particular sell off is we still haven't seen

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Speaker 1: a bunch of investors really get taken to the cleaners

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Speaker 1: just yet. We've had a few, um, one of our

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Speaker 1: Bloomberg colleagues wrote about the hedge fund in particular. But

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Speaker 1: you can imagine with everything that's gone on in the market,

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Speaker 1: you're going to get more and more of these stories emerging. Yeah.

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Speaker 1: I mean, it's the things that things are moving so

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Speaker 1: fast right now that even by the time this recording

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Speaker 1: comes out, we might hear a lot more investor blow ups.

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Speaker 1: And the one of the reasons, I think we will,

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Speaker 1: and one of the is because we've been seeing, you know,

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Speaker 1: like so many tried and true strategies in the last

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Speaker 1: couple of weeks have just completely uh failed essentially. So

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Speaker 1: various hedges that investors use to mitigate volatility in their portfolio,

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Speaker 1: whether it's treasuries or whatever, haven't behaved the way, all

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Speaker 1: kinds of dislocations. So ay, we're almost certainly going to

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Speaker 1: get those blow us and be I think the conditions

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Speaker 1: are now in place from the intensity of the moves

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Speaker 1: that we've seen in recent weeks that will sort of

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Speaker 1: finally cause some of those shoes to drop even beyond

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Speaker 1: just the you know, the sell off so to speak,

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Speaker 1: exactly right. And a lot of those strategies were things

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Speaker 1: that people supposedly had piled into, like selling volatility or

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Speaker 1: risk parity where you're sort of relying on the inverse

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Speaker 1: correlation between bonds and stocks. All of those seem to

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Speaker 1: fall apart in the recent sell off. So my question is,

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Speaker 1: if you're a professional investor, like a hedge fund or

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Speaker 1: a dealer or something like that, what separates you from

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Speaker 1: the crowd when it comes to your investment strategies? Because,

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Speaker 1: like I said, it feels like a lot of people

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Speaker 1: have sort of just crowded into the same thing in

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Speaker 1: recent years. Yeah, it has felt like that, and it

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Speaker 1: also is it's been this puzzle and I've certainly like

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Speaker 1: thought about this since well before the crisis hit, which

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Speaker 1: is that on the one hand, you don't want to

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Speaker 1: just pile into the same strategies as everyone else. Everyone

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Speaker 1: everyone knows that, Uh, that's not a particularly desirable it's

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Speaker 1: hard to stand out. On the other hand, for essentially

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Speaker 1: the last decade, we've had this situation in which the

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Speaker 1: winning strategy is to go all in on high beta

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Speaker 1: and shortening volatility. And if you did anything other than that,

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Speaker 1: essentially for a decade, you faced the situation or like

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Speaker 1: and you have to write a quarterly in estment letter

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Speaker 1: and your to your clients it's explain why you underperformed

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Speaker 1: yet again, So there has been this real pickle where

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Speaker 1: there's been one dominant strategy for so long and uh,

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Speaker 1: if any deviation meant you probably were under performance. Yeah, exactly.

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Speaker 1: There's been a real tension between doing your own thing

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Speaker 1: and profiting from basically just following the flows. In what

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Speaker 1: has been for the past ten years of really momentum

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Speaker 1: driven market but on this note of sort of standing

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Speaker 1: out from the crowd or um coming up with an

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Speaker 1: edge in professional investment. It's kind of interesting that when

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Speaker 1: people talk about business in general, h and in economics,

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Speaker 1: people are always talking about competitive advantage and you're supposed

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Speaker 1: to organize yourself around what you do best and organize

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Speaker 1: your business around it, and that's what's supposed to make

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Speaker 1: you successful. But when it comes to professional investing, you

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Speaker 1: rarely hear that. Yeah, absolutely right. Okay, So today we're

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Speaker 1: going to be speaking with someone who's actually been on

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Speaker 1: the show before, but who has written a book exactly

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Speaker 1: on this topic competitive advantage in investment and what it

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Speaker 1: means to actually be a big professional investor and how

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Speaker 1: different types of investors will approach investing in different ways.

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Speaker 1: Uh So, our guest is Steven Abraham's. He's a former

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Speaker 1: Deutsche Bank analyst. Um As I mentioned, he has been

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Speaker 1: on the show before where he was talking about the

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Speaker 1: changing world of the sell side analyst, which is a

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Speaker 1: really good thing to listen to. But he's now over

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Speaker 1: at Amherst pure Pont. He's the head of investment strategy

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Speaker 1: over there, and his book is out in April. It's

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Speaker 1: called Competitive Advantage in Investing, building winning professional portfolios. Steven,

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Speaker 1: Welcome to the show. Hi Tracy, Hi, how are you good?

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Speaker 1: Thank you for joining us. Absolutely exciting times. Um So,

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Speaker 1: maybe just to begin with, what do you think about

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Speaker 1: the big sell off recently? Pretty uh, pretty dramatic. Oh,

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Speaker 1: it has been. It has been a drama of historic proportions.

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Speaker 1: There's no doubt about that. I would say, unfortunately for

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Speaker 1: some the dramas probably not over. I know that, as

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Speaker 1: you were mentioning earlier, we've all been waiting around to

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Speaker 1: see if all of the various players are going to

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Speaker 1: make it through uh, this kind of volatility, and as

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Speaker 1: you pointed out, we've been doing okay so far. But

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Speaker 1: I would say just within you know, recent days, we've

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Speaker 1: started hearing that there are some portfolios that are in

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Speaker 1: serious trouble and and may not make it so well,

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Speaker 1: we're going to be watching things very closely. Right. It

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Speaker 1: seemed to take a step up in the seriousness really

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Speaker 1: over the last week, and I think there's a good

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Speaker 1: time to remind let listeners know that by the time

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Speaker 1: they hear this, the entire world may have since changed again.

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Speaker 1: But we are recording this on Monday, March twenty three,

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Speaker 1: so just so that people have a frame of reference,

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Speaker 1: because again, things are moving so fast. But you know,

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Speaker 1: it's one thing I feel like for the value of

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Speaker 1: risky assets to decline and stocks decline, and we all

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Speaker 1: know that stock market crashes are possible, but I think

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Speaker 1: over the last two weeks, what we've really seen on

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Speaker 1: top of that, especially over the last week, is that

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Speaker 1: various hedging strategies that people might have put in place

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Speaker 1: to mitigate a stock market decline or some other risky

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Speaker 1: asset decline, they've suddenly like stopped working as liquidity has

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Speaker 1: started to vanish. Yes, yeah, this is really a as

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Speaker 1: you're pointing out, Joe, the normal relationships between assets and hedges,

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Speaker 1: or between in one asset and another in many markets

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Speaker 1: has completely broken down. And underneath a lot of this

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Speaker 1: is just a historic reach for cash. That's true at

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Speaker 1: the level of individual businesses up and down Main Street,

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Speaker 1: but it's also true with the level of some of

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Speaker 1: the highest quality investment grade companies that apply their wears

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Speaker 1: day to day around the world. Most of those companies

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Speaker 1: are looking at economies that are effectively coming to a

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Speaker 1: complete halt and could remain basically closed for thirty to

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Speaker 1: sixty nine days. Nobody is quite sure. So they are

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Speaker 1: stockpiling cash and in the process basically selling everything that

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Speaker 1: they possibly can, and that includes securities. So the usual

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Speaker 1: ideas of stocks being richer cheap or bonds being rich

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Speaker 1: or cheap has been uh completely subsumed under the issue

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Speaker 1: of what is liquid and what can be sold and

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Speaker 1: whatever is liquid is definitely getting solved. So just on

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Speaker 1: that note, can we talk a little bit about what

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Speaker 1: traditional investment theory would have told us about that big

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Speaker 1: scramble for cash, Because on the one hand, there is

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Speaker 1: a saying that in a crisis, correlation goes to one

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Speaker 1: and everything sort of sells off at the same time.

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Speaker 1: But on the other hand, you know, the reason you

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Speaker 1: pay more for investment grade or something like the U. S.

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Speaker 1: Treasury is because it's supposed to be safe in times

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Speaker 1: like this. So what does investment theory actually tell us

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Speaker 1: about what's going on here? You know, investment theory, probably

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Speaker 1: the most relevant theory here is kind of traditional monetary

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Speaker 1: policy theory, which says that when people have doubts about

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Speaker 1: the credit worthiness of their counterparties, than any typically does

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Speaker 1: not flow, and the big issue is that with economy

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Speaker 1: is coming to a sudden stop, it really is difficult

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Speaker 1: to predict which companies have the wherewithal to make it

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Speaker 1: through this crisis. Central banks have really been flooding the

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Speaker 1: market with very plentiful and very cheap money, But the

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Speaker 1: issue is the credit worthiness of the people who need

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Speaker 1: it most now. Traditionally, this is an issue that monetary

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Speaker 1: policy assumes is going to affect banks. You know, the

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Speaker 1: depositors look at the banks, they worry that the banks

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Speaker 1: are making loans that are not prudent, and they try

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Speaker 1: to withdraw their deposits. Here in some ways it's just

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Speaker 1: the opposite. The banks have tremendous amounts of money, but

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Speaker 1: they're worried about the credit worthiness of the restaurants and

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Speaker 1: bars and taxi businesses that right now, for practical purpose

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Speaker 1: as are shut down. So UM many companies are simply

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Speaker 1: looking at whatever can trade, whatever might be liquid. So

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Speaker 1: it's really monetary policy and UM the ideas around liquidity

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Speaker 1: that apply here, and those have dominated any idea of

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Speaker 1: the ability to UM call relative value. I want to

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Speaker 1: get more into some of the ways monetary policy can

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Speaker 1: help this crisis, including again some of the things that

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Speaker 1: we're just announced this morning, but before we do, I

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Speaker 1: just want to sort of go back to this idea

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Speaker 1: of historic grab for any cash that people have, the

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Speaker 1: likes of which maybe we've never seen before or very

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Speaker 1: rarely seen. One of the things that's really striking is

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Speaker 1: in the last couple of weeks, how treasuries, which are

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Speaker 1: almost cash, like the sentence that they're completely backed by

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Speaker 1: the full faith and credit of the government, counterparty risk free,

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Speaker 1: even those started get selling off, started to be sold

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Speaker 1: off a little bit because if we think right like this,

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Speaker 1: like hierarchy of money, Yeah, holding a treasury is really

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Speaker 1: great for you know, lean times and you want to

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Speaker 1: be saved, but if you need to make a bill

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Speaker 1: payment tomorrow, you still just want cash instead. Correct. Yes,

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Speaker 1: So in the treasury market, um there has been surprising

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Speaker 1: amounts of illiquidity. Usually in the treasury market, liquidity comes

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Speaker 1: in a couple of tiers, and the most liquid tier

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Speaker 1: is the most newly issued notes or bonds, and those

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Speaker 1: still seem to be maintaining liquidity. But then the older

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Speaker 1: notes and bonds have lost um surprising amounts of liquidity,

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Speaker 1: and there have been very large leveraged treasury portfolios. Traditionally,

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Speaker 1: those portfolios would have reached through the broker deal or

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Speaker 1: bank network for financing. They may have used repo or

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Speaker 1: other forms. Many of the balance sheets that normally would

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Speaker 1: lend to them have been limited in their ability to

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Speaker 1: expand credit. So, among other things, this starts to get

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Speaker 1: at some of the core competitive advantages or disadvantages of

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Speaker 1: some of these investment platforms. The leveled players really don't

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Speaker 1: have any source of funding on their own. Banks now

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Speaker 1: have sources of funding. Traditionally they have sources of funding

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Speaker 1: through their deposit base. Now the FED and other central

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Speaker 1: banks around the world are flooding the bank system with money.

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Speaker 1: But some of the post crisis rules on UH the

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Speaker 1: proper ratios of debt to equity, and other issues limit

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Speaker 1: the ability of banks to lend endlessly, and that has

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Speaker 1: partly constrained the system, and it's led the FED, I think,

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Speaker 1: at times, to struggle with what it's supposed to do next. Yeah,

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Speaker 1: So you had a bunch of these levered funds that

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Speaker 1: were effectively picking up pennies in front of a steam

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Speaker 1: roller for years by exploiting the difference between the more

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Speaker 1: liquid futures and the cash US treasuries, and then that

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Speaker 1: trade blew up rather spectacularly a week or two ago,

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Speaker 1: and then that ended up infecting the U S treasury

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Speaker 1: market and causing all sorts of problems. Uh. Just pass

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Speaker 1: forwarding to today again, Monday March, just before we started

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Speaker 1: recording this, the Federal Reserve announced its latest attempt to

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Speaker 1: soothe the market, and that includes potentially unlimited QUEI and

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Speaker 1: also some help for companies and munies. Steve, I know

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Speaker 1: you've been thinking a lot about this, but is this

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Speaker 1: the right thing for the FED to do? Are they

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Speaker 1: on the right track or would you be encouraging to

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Speaker 1: do something else at this point? Well, probably the most

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Speaker 1: important thing the FED did this morning was announced a

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Speaker 1: couple of new facilities that allows the FED to buy

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Speaker 1: a much wider range of assets directly from investment portfolios

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Speaker 1: and businesses, so this is now no longer limited to

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Speaker 1: the typical um set of primary dealers. They announced the

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Speaker 1: term Asset Lending Facility, which basically will buy all kinds

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Speaker 1: of asset back securities as long as they have the

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Speaker 1: proper ratings, and they will buy those securities from any

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Speaker 1: eligible um US portfolio. They also announced a series two

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Speaker 1: programs directed at the corporate market, one that will buy

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Speaker 1: corporate debt directly from US companies with headquarters in the

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Speaker 1: United States and doing major business in the United States.

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Speaker 1: So this effectively creates a direct connection between investment grade

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Speaker 1: companies and the government balance sheet. They announced similar programs

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Speaker 1: for secondary corporate debt, and they expanded the program that

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Speaker 1: they announced a week ago for commercial paper. So the

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Speaker 1: FED is slowly stepping in the direction of trying to

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Speaker 1: address this cascading illiquidity across these markets. And my guess

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Speaker 1: is these new programs for ingressment investment grade paper will

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Speaker 1: have um a tremendously good effect and should start to

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Speaker 1: eliminate some of the volatility. So just to help people understand,

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Speaker 1: it's not that, you know, we're still going to have

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Speaker 1: these sort of main street economic crisis for as long

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Speaker 1: as people are locked down, as long as the virus

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Speaker 1: is here and so forth, and that's going to continue

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Speaker 1: to ravage the economy. But in the meantime, high quality

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Speaker 1: companies can at least ease up theoretically a little bit

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Speaker 1: on grabbing hold of any cash that they can in

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Speaker 1: the system, because for not for the moment, the FED

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Speaker 1: will backstop essentially their short term borrowing. So that should

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Speaker 1: the idea is that eases some of the overall desperation

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Speaker 1: that every person in every company everywhere has for liquidity. Yeah,

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Speaker 1: exactly right. Investment grade companies, large investment grade companies at

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Speaker 1: this point essentially have substantial direct assess to the FED,

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Speaker 1: and my guests would be the Fed's going to continue

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Speaker 1: providing and expanding that access as long as it sees

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Speaker 1: signs of stress. The b S facility starts to walk

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Speaker 1: down the path of providing better access to main street,

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Speaker 1: and that would have to come through the willingness of

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Speaker 1: banks to make credit card loans and auto loans. The

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Speaker 1: asset back facility basically has elements that will allow auto

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Speaker 1: dealers to finance cars and other vehicles more easily. But

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Speaker 1: you still, at this point, I think, have a problem

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Speaker 1: getting credit to a lot of smaller mainstream businesses. Maybe

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Speaker 1: the FED has a couple of tricks left in the bag,

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Speaker 1: but my guess is you're really going to need some

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Speaker 1: kind of physical policy. So I wanted to go back

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Speaker 1: to something you touched on earlier, which was this notion

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Speaker 1: of the dealers or the banks being a little bit

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Speaker 1: more restricted in terms of the amount of risk that

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Speaker 1: they can take, and maybe some of that risk having

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Speaker 1: shifted to the buy side, because a lot of people

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Speaker 1: right now are talking about how the current crisis resembles

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Speaker 1: not necessarily Lehman Brothers in two thousand and eight, but

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Speaker 1: more lt CM or long term capital management. Back in

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Speaker 1: they dabbled in a lot of derivatives UH and basically

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Speaker 1: exploded UM. So I'm just wondering if if that's the

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Speaker 1: right framework to look at the current state of the

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Speaker 1: financial industry, and if that's the reason why the FED

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Speaker 1: is quite focused on expanding UM the parties that it

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Speaker 1: can actually do business with. When it comes to QUEWI,

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Speaker 1: the biggest difference between this crisis in two thousand and

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Speaker 1: eight is that the crisis in two thousand and eight

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Speaker 1: was in the financial system. The crisis in is outside

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Speaker 1: of the financial system. UM really at its core in

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Speaker 1: corporate America UH, and as a result of corporate America

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Speaker 1: being stressed, it's a problem then on main street and

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Speaker 1: in households pretty much around the world. The FED as

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Speaker 1: a central bank is really really well equipped to pour

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Speaker 1: water on fires inside the financial system. Outside the financial system,

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Speaker 1: it has to get a little bit more creative, because

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Speaker 1: the core issue here is the fundamental credit worthiness of

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Speaker 1: main street borrowers and many homeowners. The best possible solution,

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Speaker 1: what which was in some material within the last few

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Speaker 1: days that I published in Financial Times, is to provide

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Speaker 1: government guarantees of emergency bank loans to otherwise credit worthy businesses.

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Speaker 1: We have a problem that the economies of ground to

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Speaker 1: a sudden stop, but I think it's widely expected that

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Speaker 1: after a ninety or a hundred and eighty day period,

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Speaker 1: many of these businesses will be viable again. So the

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Speaker 1: trick is bridging that period by providing credit. Banks I

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Speaker 1: think have plenty of money, but I think any banker

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Speaker 1: hesitates to lend to a business about to see its

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Speaker 1: earnings evaporate. If you had, if you had the government

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Speaker 1: provide guarantees, I think banks would have a lot more

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Speaker 1: courage in that situation, right, I really Uh. There was

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Speaker 1: this great LARRYUS Summers quote that he said a couple

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Speaker 1: of weeks ago, and I keep thinking about it. He's

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Speaker 1: basically saying, like somehow I forget his working exactly, But

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Speaker 1: essentially the challenges how do you freeze financial or so

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Speaker 1: how do you freeze economic time, while uh, financial time

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Speaker 1: continues in its current state, and this idea is like, Okay,

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Speaker 1: everyone knows we have to stay inside. Everyone knows that

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Speaker 1: there are a lot of viable businesses that will need

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Speaker 1: to shut their doors for days or whatever. But the

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Speaker 1: bills keep coming in regardless and essentially and as you say,

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Speaker 1: that sort of outside of the monetary system and subside

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Speaker 1: of the banking system per se. So it's somehow going

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Speaker 1: to have to be an Act of Congress to come

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Speaker 1: up with a solution that lets everyone pay their bills

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Speaker 1: during the essential time of the FACTI lockdown. Yes, that's

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Speaker 1: exactly right. So, Steven, I wanted to get to your book, uh,

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Speaker 1: and we spoke a little bit about it earlier. But

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Speaker 1: you know, when people talk about investment strategy, they're usually

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Speaker 1: treating all the investors in a sort of similar way.

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Speaker 1: But as you point out, people tend to do things

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Speaker 1: differently according to their competitive advantages. Could you maybe just

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Speaker 1: walk us through, uh, the premise of your book and

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Speaker 1: why this was something that interested you. Yeah. Absolutely. I

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Speaker 1: think that when you sit in a seat like mine,

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Speaker 1: where you're really advising a wide range of investors, you

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Speaker 1: start to see over time that the players matter just

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Speaker 1: as much as the market does when it comes to

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Speaker 1: UM investing. You can UM look from banks to insurance companies,

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Speaker 1: mutual funds to hedge funds, reets, sovereign wealth funds. They

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Speaker 1: all operate UM with very very distinct advantages and disadvantages,

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Speaker 1: and those kinds of things not only shape what they

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Speaker 1: buy how they use the as assets, but UM it

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Speaker 1: also ends up turning around and affecting the value of

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Speaker 1: those assets in the marketplace. And they're just plenty of

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Speaker 1: examples of that, including the kind of markets that we're

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Speaker 1: looking at right now. And UH I thought for years

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Speaker 1: that we needed something that went through these different kinds

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Speaker 1: of investors and talked about what their strengths and weaknesses

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Speaker 1: might be and how it affected assets. And that's what

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Speaker 1: led me to write the book to expand this further

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Speaker 1: strengths and weaknesses of different types of assets. What does

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Speaker 1: that mean specifically, Well, I'll give you an example. It's

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Speaker 1: very relevant to where we are now. UM. Let's take

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Speaker 1: UM source of funds. Some investment platforms just have tremendous,

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Speaker 1: tremendous advantage in the variety and the low cost of

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Speaker 1: their funding. And for example, right now, the the eight

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Speaker 1: hundred pound guerrilla on that front is the banking system.

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Speaker 1: So banks traditionally have a really wide range of sources

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Speaker 1: of funds through their retail deposit base. Some of their

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Speaker 1: retail deposits are a kind of fast deposits from big

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Speaker 1: corporations that are moving money through their accounts quickly. Other

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Speaker 1: other deposits are very very long, steady and stable UH

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Speaker 1: sources of funds. Like, for example, if you look at

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Speaker 1: my checking account, I've probably had some at least minimal

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Speaker 1: balance in my checking account for decades, So banks could

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Speaker 1: use my money that's there for decades, your money that's

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Speaker 1: there for decades, other people's money that may be there

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Speaker 1: for far shorter periods of time, corporate money which may

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Speaker 1: come in and out day to day, and they can

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Speaker 1: use that to buy or fund a wide range of

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Speaker 1: not only loans, but securities. If you want to go

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Speaker 1: to the opposite extreme, you could look at hedge funds,

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Speaker 1: for example, or reads, which usually borrow based on repurchase

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Speaker 1: or repo agreements UH, and those repo or repurchase agreements

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Speaker 1: often last only for a day and have to be

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Speaker 1: renewed every day. Right. That leads those kinds of organizations

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Speaker 1: kinds of investors highly subject to markets where suddenly there's

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Speaker 1: a run on liquidity, and those are the those are

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Speaker 1: the folks that are struggling at this point, right, some

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Speaker 1: of them would have done that levered US treasury trade

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Speaker 1: that we just described. So I guess the question is

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Speaker 1: knowing that you have that sort of short term day

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Speaker 1: to day funding, shouldn't that change the way you invest

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Speaker 1: potentially or at least the way that you hedge. Absolutely? Um.

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Speaker 1: I mean when it comes to the way you invest,

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Speaker 1: and you see this in the portfolios at least most

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Speaker 1: of the portfolios of prudent leverage investors, that almost forces

401
00:28:13,359 --> 00:28:18,560
Speaker 1: you to hold highly liquid assets. So does it make

402
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Speaker 1: sense to have levered portfolios of treasuries? Um, Yes, it

403
00:28:24,160 --> 00:28:28,359
Speaker 1: probably does. Would it makes sense to have leveraged portfolios

404
00:28:28,480 --> 00:28:33,639
Speaker 1: of agency mortgage backed securities? It probably does. Would it

405
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Speaker 1: make sense for you to have leveraged portfolios of less

406
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Speaker 1: liquid assets like um certain forms of a corporate debt

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Speaker 1: or loans that may not be easy to sell on

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Speaker 1: short notice. Once you start leveraging less liquid assets, you

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00:28:55,200 --> 00:29:00,480
Speaker 1: begin to take much more risk uh of a liquidity

410
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Speaker 1: crunch of the sort that we're in now, and what

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00:29:03,320 --> 00:29:07,760
Speaker 1: you can see is that in today's marketing current circumstances,

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Speaker 1: lever portfolios of the most liquid assets have been able

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Speaker 1: to delever, not necessarily um in a pretty fashion, but

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Speaker 1: nevertheless they've been able to de lever, while levery portfolios

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00:29:22,960 --> 00:29:26,040
Speaker 1: of less liquid assets have struggled, and at times I

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Speaker 1: think some of those organizations have been on the brink

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Speaker 1: of failing to meet calls for additional margin, additional cash

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Speaker 1: and could go out of business. So a lot of

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Speaker 1: this I think makes sense to people right now. I mean,

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Speaker 1: we're looking in a market that's been you know, arguably

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Speaker 1: some of the most most volatile, complete turmoil that many

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Speaker 1: people have ever seen in their careers. But you know,

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Speaker 1: like in the normal times, you know, two thousand thirt

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Speaker 1: was there, Just like, how do you get this message

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Speaker 1: across and how do you deal with the issue that

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Speaker 1: I was sort of talking about at the beginning, where

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Speaker 1: prior to right now, the dominant strategy for an investor

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Speaker 1: would essentially just be too go all in on high

429
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Speaker 1: baya or short volatility or just that that historical correlations

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Speaker 1: UH will maintain, Like how do you how do you

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Speaker 1: apply these lessons to non crisis periods and be a

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Speaker 1: competitive investor. Well, for example, if we we step outside

433
00:30:30,880 --> 00:30:34,840
Speaker 1: the current situation, taking insurers for example, UM, I know

434
00:30:35,320 --> 00:30:38,120
Speaker 1: it probably is not the usual way people think about

435
00:30:38,120 --> 00:30:42,400
Speaker 1: insurance companies, but when you hand when you pay your

436
00:30:43,120 --> 00:30:48,520
Speaker 1: UH life insurance bill or your auto bill, in many cases,

437
00:30:49,320 --> 00:30:54,320
Speaker 1: you're really handing those insurance companies a dollar that at

438
00:30:54,360 --> 00:30:57,080
Speaker 1: some point in the future they're going to hand right

439
00:30:57,120 --> 00:31:01,640
Speaker 1: back to you. I mean, an auto UH policy is

440
00:31:01,680 --> 00:31:06,040
Speaker 1: probably the simplest. You don't expect to be in an accident,

441
00:31:06,360 --> 00:31:10,520
Speaker 1: but if you are fender bender or otherwise, the auto

442
00:31:10,560 --> 00:31:13,120
Speaker 1: companies are going to pay to get your car fixed.

443
00:31:14,000 --> 00:31:17,640
Speaker 1: You you could have held that dollar in your savings account,

444
00:31:17,720 --> 00:31:21,200
Speaker 1: but instead you're giving it to the insurance company, and

445
00:31:21,240 --> 00:31:24,360
Speaker 1: the insurance company gives it back to you. Between the

446
00:31:24,400 --> 00:31:26,560
Speaker 1: time you give it to the insurance company and the

447
00:31:26,600 --> 00:31:29,440
Speaker 1: time that company pays it back to you, it has

448
00:31:29,480 --> 00:31:32,400
Speaker 1: the opportunity to invest in a wide range of assets.

449
00:31:33,560 --> 00:31:39,360
Speaker 1: So with life insurance companies, especially since the time between

450
00:31:39,480 --> 00:31:42,920
Speaker 1: getting the dollar and paying it back is so long,

451
00:31:44,000 --> 00:31:51,280
Speaker 1: life insurers are just beautifully equipped for owning illiquid assets. UM.

452
00:31:51,360 --> 00:31:56,400
Speaker 1: They can hold loans of wide range, they can hold

453
00:31:57,160 --> 00:32:02,000
Speaker 1: securities that are private play easements instead of public securities.

454
00:32:02,600 --> 00:32:06,120
Speaker 1: They're able to invest in real estate, where the return

455
00:32:06,200 --> 00:32:10,520
Speaker 1: to the investment really requires a long horizon and the

456
00:32:10,560 --> 00:32:17,040
Speaker 1: ability to tolerate potential swings in prices. If you were

457
00:32:17,120 --> 00:32:21,040
Speaker 1: running a mutual fund, in contrast, it would be very

458
00:32:21,080 --> 00:32:26,440
Speaker 1: difficult to hold securities that have limited liquidity. That's because

459
00:32:26,440 --> 00:32:31,640
Speaker 1: a mutual fund has to provide daily returns to their shareholders.

460
00:32:31,680 --> 00:32:35,560
Speaker 1: So just if you look at funding, and then you

461
00:32:35,600 --> 00:32:40,280
Speaker 1: look at other aspects of these platforms, like how the

462
00:32:40,400 --> 00:32:44,880
Speaker 1: accountants measure these things, some are really well equipped to

463
00:32:44,920 --> 00:32:48,280
Speaker 1: hold the liquid assets and others aren't well equipped. You

464
00:32:48,320 --> 00:32:50,600
Speaker 1: can see that in a bunch of other dimensions as well.

465
00:32:52,360 --> 00:32:56,240
Speaker 1: Where do you see the most extreme liquidity mismatches in

466
00:32:56,560 --> 00:32:59,800
Speaker 1: the current sell off? Is there something specifically that you're

467
00:33:00,080 --> 00:33:06,560
Speaker 1: um that you're watching out for. Well, in this setting,

468
00:33:07,520 --> 00:33:11,040
Speaker 1: the place you always have to look first are the

469
00:33:11,160 --> 00:33:15,440
Speaker 1: most highly levered investment portfolios as well as the most

470
00:33:15,560 --> 00:33:20,360
Speaker 1: highly levered corporate balance sheets, and both of those markets

471
00:33:20,400 --> 00:33:26,360
Speaker 1: are struggling, both of them. Um. So, we've heard reports

472
00:33:26,400 --> 00:33:30,600
Speaker 1: over the last couple of days of large hedge fund

473
00:33:30,600 --> 00:33:36,400
Speaker 1: portfolios that are circulating and looking for bids. We've heard

474
00:33:36,920 --> 00:33:43,840
Speaker 1: of um significant demands for liquidity from real estate investment trusts,

475
00:33:43,880 --> 00:33:48,800
Speaker 1: which also tend to be leveraged. And you can clearly

476
00:33:48,920 --> 00:33:53,080
Speaker 1: look at the corporate world, to some extent investment grade,

477
00:33:53,520 --> 00:33:58,680
Speaker 1: but very very clearly in the leverage loan market, where

478
00:33:58,720 --> 00:34:03,360
Speaker 1: corporations are drawing down their credit lines and trying to

479
00:34:03,920 --> 00:34:08,040
Speaker 1: fortify their balance sheet for periods of you know, really

480
00:34:08,080 --> 00:34:11,239
Speaker 1: difficult earnings ahead. Those are the places I think that

481
00:34:11,320 --> 00:34:14,960
Speaker 1: are right now most at risk, and we're seeing that

482
00:34:16,640 --> 00:34:20,600
Speaker 1: they'll they'll pay for liquidity at almost any price. How

483
00:34:20,600 --> 00:34:25,279
Speaker 1: do you identify opportunities though, because you know it's really

484
00:34:25,320 --> 00:34:28,319
Speaker 1: bad right now, it also looked really bad a week ago,

485
00:34:28,600 --> 00:34:30,439
Speaker 1: And if you try to be here, I said, okay,

486
00:34:30,480 --> 00:34:33,520
Speaker 1: I'm gonna be the liquidity provider. You know, I'm gonna

487
00:34:33,560 --> 00:34:35,880
Speaker 1: be the liquidity provider that jumps into the panic. And

488
00:34:35,960 --> 00:34:37,799
Speaker 1: you said that a week ago you might already be

489
00:34:37,960 --> 00:34:40,439
Speaker 1: you might already be finished, you might already be taken out.

490
00:34:40,920 --> 00:34:46,160
Speaker 1: So how do you think about risk management and exploiting

491
00:34:46,160 --> 00:34:50,200
Speaker 1: these opportunities where people will pay almost any price for liquidity,

492
00:34:50,239 --> 00:34:55,760
Speaker 1: but not blowing up yourself in the process By mistiming. Well,

493
00:34:55,880 --> 00:34:59,360
Speaker 1: So if I started with these investment platforms, the strongest

494
00:34:59,400 --> 00:35:01,360
Speaker 1: players in the market are going to be the ones

495
00:35:01,600 --> 00:35:08,040
Speaker 1: with the most capital um, the deepest and lowest cost,

496
00:35:08,760 --> 00:35:13,120
Speaker 1: and widest variety of funding. Those are the places that

497
00:35:13,160 --> 00:35:17,000
Speaker 1: are going to have the strong hand. You might think

498
00:35:17,040 --> 00:35:20,000
Speaker 1: that that would include banks, and to some extent that

499
00:35:20,080 --> 00:35:26,880
Speaker 1: might be true, but regulations limit the degree of credit

500
00:35:27,000 --> 00:35:30,120
Speaker 1: risk that banks can take, so while they have great

501
00:35:30,160 --> 00:35:36,520
Speaker 1: advantages in capital and funding, have some disadvantages in regulatory constraint.

502
00:35:37,360 --> 00:35:42,280
Speaker 1: Insurers are also likely to be in a strong position,

503
00:35:42,920 --> 00:35:49,640
Speaker 1: especially insurers that have strong capital and deep access to funds.

504
00:35:49,640 --> 00:35:52,719
Speaker 1: So that would probably include most of the larger players

505
00:35:53,719 --> 00:35:56,120
Speaker 1: and some of the players that are using the investment

506
00:35:56,160 --> 00:36:00,520
Speaker 1: grade bond market to raise cash at this point. I mean, notably,

507
00:36:00,719 --> 00:36:06,560
Speaker 1: you've seen Berkshire Hathaway in past crises right to the rescue,

508
00:36:07,040 --> 00:36:11,840
Speaker 1: and although that clearly reflects the genius of war and Buffett,

509
00:36:11,840 --> 00:36:14,840
Speaker 1: there is no doubt at all, it also reflects the

510
00:36:14,920 --> 00:36:18,719
Speaker 1: strength of the insurance balance sheet that he's playing off of.

511
00:36:19,480 --> 00:36:23,880
Speaker 1: So those are the those are the strong platforms. Those

512
00:36:23,960 --> 00:36:31,600
Speaker 1: platforms have the ability two buy assets that otherwise would

513
00:36:31,600 --> 00:36:37,120
Speaker 1: be in free fall, they're not subject to usually to

514
00:36:37,280 --> 00:36:43,920
Speaker 1: margin calls. Um, they're accounting rules are very very kind

515
00:36:44,600 --> 00:36:49,000
Speaker 1: two assets that show price volatility. So what we've been

516
00:36:49,040 --> 00:36:53,000
Speaker 1: advising investors to do when they have balance sheets like

517
00:36:53,080 --> 00:36:58,520
Speaker 1: that is to buy fundamentally sound cash flows at widespreads

518
00:36:59,120 --> 00:37:03,080
Speaker 1: and those would in flute some government back cash flows

519
00:37:03,120 --> 00:37:06,360
Speaker 1: that are trading at distress levels. And when it comes

520
00:37:06,400 --> 00:37:11,200
Speaker 1: to the corporate market, cash flows from corporations that have

521
00:37:11,400 --> 00:37:15,720
Speaker 1: adequate liquidity to weather the next three to six months

522
00:37:16,880 --> 00:37:19,759
Speaker 1: and have the potential to come out of this crisis

523
00:37:20,440 --> 00:37:23,919
Speaker 1: potentially stronger than when they went in. And those would

524
00:37:23,960 --> 00:37:28,520
Speaker 1: be the kind of investments that right that we've been advising.

525
00:37:28,760 --> 00:37:30,160
Speaker 1: So then you don't have to be a hero. It's

526
00:37:30,200 --> 00:37:34,080
Speaker 1: not really about timing the bottom or anything like that.

527
00:37:34,400 --> 00:37:37,040
Speaker 1: Or this fell another ten percent after I bought it,

528
00:37:37,640 --> 00:37:41,920
Speaker 1: but take there are looking for opportunities in which the

529
00:37:41,960 --> 00:37:46,640
Speaker 1: spreads are so wide and the sort of uh predictability

530
00:37:46,640 --> 00:37:49,640
Speaker 1: of future cash flows for whatever reason, as you mentioned,

531
00:37:49,800 --> 00:37:54,359
Speaker 1: something like our insurance et cetera, are so consistent that

532
00:37:54,880 --> 00:37:59,520
Speaker 1: your your margin for error is quite large. Yes, I mean,

533
00:37:59,600 --> 00:38:03,520
Speaker 1: timing might be everything in comedy, but most research shows

534
00:38:03,640 --> 00:38:07,680
Speaker 1: that it doesn't really amount to much in investing. So

535
00:38:08,480 --> 00:38:11,360
Speaker 1: if you look at some of these stronger balance sheets,

536
00:38:11,880 --> 00:38:14,600
Speaker 1: they are going to be able to absorb these assets

537
00:38:15,280 --> 00:38:24,200
Speaker 1: and honestly um provide good returns to their shareholders for

538
00:38:24,719 --> 00:38:30,440
Speaker 1: years and years to come. Right, Stephen, we really appreciate

539
00:38:30,480 --> 00:38:33,479
Speaker 1: you coming back on the show, and we're definitely gonna

540
00:38:33,719 --> 00:38:35,560
Speaker 1: look out for your book when it comes out and

541
00:38:35,640 --> 00:38:39,920
Speaker 1: equal thanks so much, great, Thanks Tracy, Thanks Joe. Thanks

542
00:38:39,920 --> 00:38:49,760
Speaker 1: that was great. Joe. I was just thinking, uh, Warren

543
00:38:49,800 --> 00:38:55,600
Speaker 1: Buffett has actually been notably absent from the recent sell off. Yeah, right,

544
00:38:55,640 --> 00:38:58,360
Speaker 1: like we have yet to see uh an op ed

545
00:38:58,400 --> 00:39:00,480
Speaker 1: from him in the New York Times saying, the buy

546
00:39:00,520 --> 00:39:03,640
Speaker 1: American I am, and I think, and I wonder if

547
00:39:04,400 --> 00:39:07,759
Speaker 1: like everyone is just so shell shocked, what does that

548
00:39:08,000 --> 00:39:12,359
Speaker 1: just maybe that includes Warren Buffett? Like the degree of uncertainty.

549
00:39:12,400 --> 00:39:14,319
Speaker 1: I mean I don't know, like I mean, I don't

550
00:39:14,320 --> 00:39:16,600
Speaker 1: know like what what he's thinking, but like the degree

551
00:39:17,200 --> 00:39:21,440
Speaker 1: of uncertainty here at the sort of path dependency and

552
00:39:21,480 --> 00:39:25,000
Speaker 1: the speed with which things can fire, a lot of control.

553
00:39:25,640 --> 00:39:27,919
Speaker 1: I mean, like look in two thousand and two thousand nine,

554
00:39:29,040 --> 00:39:32,160
Speaker 1: we always knew there was a we didn't know that

555
00:39:32,280 --> 00:39:34,680
Speaker 1: they were going to get there, but it was you know,

556
00:39:34,840 --> 00:39:37,480
Speaker 1: as our guests was talking about, it was a monetary phenomenon,

557
00:39:37,560 --> 00:39:39,480
Speaker 1: was a crisis of the banks. And you can theoretically

558
00:39:39,520 --> 00:39:42,719
Speaker 1: always paper over a monetary phenomena, but when you have

559
00:39:42,800 --> 00:39:47,400
Speaker 1: a real economic crisis where you like really do not

560
00:39:47,600 --> 00:39:50,000
Speaker 1: know how long it will be before people are comfortable

561
00:39:50,239 --> 00:39:54,600
Speaker 1: spending money in retail establishments, again, I just then the

562
00:39:55,080 --> 00:39:58,040
Speaker 1: degree of uncertainty and the desire to hoard liquidity or

563
00:39:58,080 --> 00:40:00,959
Speaker 1: hard cash when you have it. I just think that's

564
00:40:00,960 --> 00:40:03,600
Speaker 1: like what makes this almost feels like incomparable to anything

565
00:40:03,600 --> 00:40:07,839
Speaker 1: we've seen. Yeah, the speed has certainly been unprecedented. And

566
00:40:07,880 --> 00:40:10,120
Speaker 1: even in two thousand and eight in the financial crisis,

567
00:40:10,120 --> 00:40:13,280
Speaker 1: when we were worried about the banking system collapsing, people

568
00:40:13,320 --> 00:40:18,440
Speaker 1: still went out and you know, bought sandwiches or you know,

569
00:40:18,520 --> 00:40:22,360
Speaker 1: like their haircut and things like that. That's just not

570
00:40:22,520 --> 00:40:25,359
Speaker 1: happening in the current situation. So it does raise all

571
00:40:25,400 --> 00:40:28,560
Speaker 1: sorts of questions. The other thing I like about Steven's

572
00:40:28,719 --> 00:40:32,839
Speaker 1: framework in particular, this idea of you know, different investors

573
00:40:33,280 --> 00:40:37,560
Speaker 1: have different ways of funding themselves, different advantages. It's that

574
00:40:37,680 --> 00:40:41,040
Speaker 1: kind of detail that I find a lot of investment

575
00:40:41,080 --> 00:40:44,560
Speaker 1: theory just sort of glosses over, like obviously big investors

576
00:40:44,640 --> 00:40:49,440
Speaker 1: want to buy low and sell high. But actually, as

577
00:40:49,440 --> 00:40:52,840
Speaker 1: Stephen was saying, there's a funding consideration there too, and

578
00:40:52,920 --> 00:40:55,080
Speaker 1: you always want to be sort of matching your funding

579
00:40:55,160 --> 00:41:00,239
Speaker 1: with your investment horizon or the assets maturity. Yeah, it's

580
00:41:00,280 --> 00:41:03,160
Speaker 1: a really it's a really good thing to uh to

581
00:41:03,239 --> 00:41:05,959
Speaker 1: think about right now in terms of like how people

582
00:41:06,000 --> 00:41:09,080
Speaker 1: are thinking about whether there are in fact opportunities in

583
00:41:09,080 --> 00:41:12,759
Speaker 1: this market, right and whether there are vulnerabilities because as

584
00:41:12,800 --> 00:41:16,000
Speaker 1: we've seen, this is sort of so far. I hope

585
00:41:16,000 --> 00:41:18,359
Speaker 1: this doesn't change by the time this episode comes out,

586
00:41:18,400 --> 00:41:21,200
Speaker 1: but so far this has sort of been vindication for

587
00:41:21,239 --> 00:41:24,680
Speaker 1: the regulators. Right. They encourage banks to hold a lot

588
00:41:24,400 --> 00:41:28,359
Speaker 1: of risk to turn out their funding and it's sort

589
00:41:28,360 --> 00:41:31,520
Speaker 1: of paid off in this situation. But the downside, of course,

590
00:41:31,600 --> 00:41:33,279
Speaker 1: is that you have a lot of stuff that's just

591
00:41:33,400 --> 00:41:37,160
Speaker 1: held outside the banking system and might be harder for

592
00:41:37,320 --> 00:41:41,120
Speaker 1: the Federal Reserve and other regulators to actually help. Yeah,

593
00:41:41,200 --> 00:41:45,040
Speaker 1: exactly right. So so far, there's a there's a argument

594
00:41:45,080 --> 00:41:47,320
Speaker 1: to be made that the bank that the post crisis

595
00:41:47,360 --> 00:41:50,960
Speaker 1: regulations have done a good job, because we have yet

596
00:41:51,000 --> 00:41:55,880
Speaker 1: to hear about major concerns with systemically important financial institutions

597
00:41:55,920 --> 00:41:59,120
Speaker 1: because all of the true risk has been pressed out

598
00:41:59,120 --> 00:42:02,319
Speaker 1: so so far, there's definitely a case to be made

599
00:42:02,360 --> 00:42:05,680
Speaker 1: that the regulations are working, as the number of times

600
00:42:05,719 --> 00:42:12,560
Speaker 1: you're saying so far in that sentence's nervous. But yeah, yeah,

601
00:42:12,880 --> 00:42:16,080
Speaker 1: let's hope it stays true by the time this episode

602
00:42:16,320 --> 00:42:20,200
Speaker 1: comes out. Shall we leave it there? Yes? Okay, This

603
00:42:20,239 --> 00:42:23,120
Speaker 1: has been another edition of the ad Thoughts podcast. I'm

604
00:42:23,160 --> 00:42:26,600
Speaker 1: Tracy Alloway. You can follow me on Twitter at Tracy Alloway,

605
00:42:26,760 --> 00:42:29,480
Speaker 1: and I'm Joe Wisenthal. You can follow me on Twitter

606
00:42:29,640 --> 00:42:33,040
Speaker 1: at the Stalwart. And you should follow our producer on Twitter,

607
00:42:33,120 --> 00:42:37,200
Speaker 1: Laura Carlson. She's at Laura and Carlson. Follow the Bloomberg

608
00:42:37,239 --> 00:42:41,520
Speaker 1: head of podcasts, Francesca Levi at Francesca Today, and all

609
00:42:41,600 --> 00:42:43,960
Speaker 1: of the Bloomberg podcasts. You can find them under the

610
00:42:44,040 --> 00:43:08,520
Speaker 1: handle at podcasts. Thanks for listening. Year to e