Speaker 1: Hi, all Thoughts listeners. Joe and I are working our
Speaker 1: way through a pretty big backlog of episodes. So what
Speaker 1: that means is what you are about to hear is
Speaker 1: something that was reported quite a while ago. We recorded
Speaker 1: this one back on March three. We were in the
Speaker 1: midst of the big market crash back then, but we
Speaker 1: hadn't really seen the effects of that crash work their
Speaker 1: way through the financial system. So you're gonna hear Joe
Speaker 1: and I talk a lot about how weird it is
Speaker 1: that we haven't seen any big trading blow ups just yet.
Speaker 1: Of course, since March we have had a few, notably
Speaker 1: a big oil fund in Singapore and also a hedge
Speaker 1: fund called Malachite in New York. I think, if anything,
Speaker 1: it makes the episode more interesting and the themes discussed
Speaker 1: probably more estion. So I hope you enjoyed. Thanks for listening. Hello,
Speaker 1: and welcome to another episode of the All Thoughts podcast.
Speaker 1: I'm Tracy Allaway and I'm Joe. WI isn't all so, Joe?
Speaker 1: You know what I've been thinking about quite a lot recently. Um, Well,
Speaker 1: I don't know. Is it the same thing that literally
Speaker 1: everyone across the entire world can't stop thinking about and
Speaker 1: dreaming about and talking about or is there something else
Speaker 1: going on? Wait? Are you thinking of the virus or
Speaker 1: the market sell off? I think I've been exposed to
Speaker 1: financial markets for too long because they're sort of both
Speaker 1: entwined in my mind. I literally like dreamed last night
Speaker 1: about both the virus and the market crash, and I
Speaker 1: have not thought about anything else. So, but now, what
Speaker 1: is the specific thing that you yourself are thinking about
Speaker 1: these days? Okay, it's kind of an offshoot of the
Speaker 1: market crash, and it's basically, uh, investor blow ups, So okay,
Speaker 1: that's that's timely. Yeah. So one of the interesting things
Speaker 1: about this particular sell off is we still haven't seen
Speaker 1: a bunch of investors really get taken to the cleaners
Speaker 1: just yet. We've had a few, um, one of our
Speaker 1: Bloomberg colleagues wrote about the hedge fund in particular. But
Speaker 1: you can imagine with everything that's gone on in the market,
Speaker 1: you're going to get more and more of these stories emerging. Yeah.
Speaker 1: I mean, it's the things that things are moving so
Speaker 1: fast right now that even by the time this recording
Speaker 1: comes out, we might hear a lot more investor blow ups.
Speaker 1: And the one of the reasons, I think we will,
Speaker 1: and one of the is because we've been seeing, you know,
Speaker 1: like so many tried and true strategies in the last
Speaker 1: couple of weeks have just completely uh failed essentially. So
Speaker 1: various hedges that investors use to mitigate volatility in their portfolio,
Speaker 1: whether it's treasuries or whatever, haven't behaved the way, all
Speaker 1: kinds of dislocations. So ay, we're almost certainly going to
Speaker 1: get those blow us and be I think the conditions
Speaker 1: are now in place from the intensity of the moves
Speaker 1: that we've seen in recent weeks that will sort of
Speaker 1: finally cause some of those shoes to drop even beyond
Speaker 1: just the you know, the sell off so to speak,
Speaker 1: exactly right. And a lot of those strategies were things
Speaker 1: that people supposedly had piled into, like selling volatility or
Speaker 1: risk parity where you're sort of relying on the inverse
Speaker 1: correlation between bonds and stocks. All of those seem to
Speaker 1: fall apart in the recent sell off. So my question is,
Speaker 1: if you're a professional investor, like a hedge fund or
Speaker 1: a dealer or something like that, what separates you from
Speaker 1: the crowd when it comes to your investment strategies? Because,
Speaker 1: like I said, it feels like a lot of people
Speaker 1: have sort of just crowded into the same thing in
Speaker 1: recent years. Yeah, it has felt like that, and it
Speaker 1: also is it's been this puzzle and I've certainly like
Speaker 1: thought about this since well before the crisis hit, which
Speaker 1: is that on the one hand, you don't want to
Speaker 1: just pile into the same strategies as everyone else. Everyone
Speaker 1: everyone knows that, Uh, that's not a particularly desirable it's
Speaker 1: hard to stand out. On the other hand, for essentially
Speaker 1: the last decade, we've had this situation in which the
Speaker 1: winning strategy is to go all in on high beta
Speaker 1: and shortening volatility. And if you did anything other than that,
Speaker 1: essentially for a decade, you faced the situation or like
Speaker 1: and you have to write a quarterly in estment letter
Speaker 1: and your to your clients it's explain why you underperformed
Speaker 1: yet again, So there has been this real pickle where
Speaker 1: there's been one dominant strategy for so long and uh,
Speaker 1: if any deviation meant you probably were under performance. Yeah, exactly.
Speaker 1: There's been a real tension between doing your own thing
Speaker 1: and profiting from basically just following the flows. In what
Speaker 1: has been for the past ten years of really momentum
Speaker 1: driven market but on this note of sort of standing
Speaker 1: out from the crowd or um coming up with an
Speaker 1: edge in professional investment. It's kind of interesting that when
Speaker 1: people talk about business in general, h and in economics,
Speaker 1: people are always talking about competitive advantage and you're supposed
Speaker 1: to organize yourself around what you do best and organize
Speaker 1: your business around it, and that's what's supposed to make
Speaker 1: you successful. But when it comes to professional investing, you
Speaker 1: rarely hear that. Yeah, absolutely right. Okay, So today we're
Speaker 1: going to be speaking with someone who's actually been on
Speaker 1: the show before, but who has written a book exactly
Speaker 1: on this topic competitive advantage in investment and what it
Speaker 1: means to actually be a big professional investor and how
Speaker 1: different types of investors will approach investing in different ways.
Speaker 1: Uh So, our guest is Steven Abraham's. He's a former
Speaker 1: Deutsche Bank analyst. Um As I mentioned, he has been
Speaker 1: on the show before where he was talking about the
Speaker 1: changing world of the sell side analyst, which is a
Speaker 1: really good thing to listen to. But he's now over
Speaker 1: at Amherst pure Pont. He's the head of investment strategy
Speaker 1: over there, and his book is out in April. It's
Speaker 1: called Competitive Advantage in Investing, building winning professional portfolios. Steven,
Speaker 1: Welcome to the show. Hi Tracy, Hi, how are you good?
Speaker 1: Thank you for joining us. Absolutely exciting times. Um So,
Speaker 1: maybe just to begin with, what do you think about
Speaker 1: the big sell off recently? Pretty uh, pretty dramatic. Oh,
Speaker 1: it has been. It has been a drama of historic proportions.
Speaker 1: There's no doubt about that. I would say, unfortunately for
Speaker 1: some the dramas probably not over. I know that, as
Speaker 1: you were mentioning earlier, we've all been waiting around to
Speaker 1: see if all of the various players are going to
Speaker 1: make it through uh, this kind of volatility, and as
Speaker 1: you pointed out, we've been doing okay so far. But
Speaker 1: I would say just within you know, recent days, we've
Speaker 1: started hearing that there are some portfolios that are in
Speaker 1: serious trouble and and may not make it so well,
Speaker 1: we're going to be watching things very closely. Right. It
Speaker 1: seemed to take a step up in the seriousness really
Speaker 1: over the last week, and I think there's a good
Speaker 1: time to remind let listeners know that by the time
Speaker 1: they hear this, the entire world may have since changed again.
Speaker 1: But we are recording this on Monday, March twenty three,
Speaker 1: so just so that people have a frame of reference,
Speaker 1: because again, things are moving so fast. But you know,
Speaker 1: it's one thing I feel like for the value of
Speaker 1: risky assets to decline and stocks decline, and we all
Speaker 1: know that stock market crashes are possible, but I think
Speaker 1: over the last two weeks, what we've really seen on
Speaker 1: top of that, especially over the last week, is that
Speaker 1: various hedging strategies that people might have put in place
Speaker 1: to mitigate a stock market decline or some other risky
Speaker 1: asset decline, they've suddenly like stopped working as liquidity has
Speaker 1: started to vanish. Yes, yeah, this is really a as
Speaker 1: you're pointing out, Joe, the normal relationships between assets and hedges,
Speaker 1: or between in one asset and another in many markets
Speaker 1: has completely broken down. And underneath a lot of this
Speaker 1: is just a historic reach for cash. That's true at
Speaker 1: the level of individual businesses up and down Main Street,
Speaker 1: but it's also true with the level of some of
Speaker 1: the highest quality investment grade companies that apply their wears
Speaker 1: day to day around the world. Most of those companies
Speaker 1: are looking at economies that are effectively coming to a
Speaker 1: complete halt and could remain basically closed for thirty to
Speaker 1: sixty nine days. Nobody is quite sure. So they are
Speaker 1: stockpiling cash and in the process basically selling everything that
Speaker 1: they possibly can, and that includes securities. So the usual
Speaker 1: ideas of stocks being richer cheap or bonds being rich
Speaker 1: or cheap has been uh completely subsumed under the issue
Speaker 1: of what is liquid and what can be sold and
Speaker 1: whatever is liquid is definitely getting solved. So just on
Speaker 1: that note, can we talk a little bit about what
Speaker 1: traditional investment theory would have told us about that big
Speaker 1: scramble for cash, Because on the one hand, there is
Speaker 1: a saying that in a crisis, correlation goes to one
Speaker 1: and everything sort of sells off at the same time.
Speaker 1: But on the other hand, you know, the reason you
Speaker 1: pay more for investment grade or something like the U. S.
Speaker 1: Treasury is because it's supposed to be safe in times
Speaker 1: like this. So what does investment theory actually tell us
Speaker 1: about what's going on here? You know, investment theory, probably
Speaker 1: the most relevant theory here is kind of traditional monetary
Speaker 1: policy theory, which says that when people have doubts about
Speaker 1: the credit worthiness of their counterparties, than any typically does
Speaker 1: not flow, and the big issue is that with economy
Speaker 1: is coming to a sudden stop, it really is difficult
Speaker 1: to predict which companies have the wherewithal to make it
Speaker 1: through this crisis. Central banks have really been flooding the
Speaker 1: market with very plentiful and very cheap money, But the
Speaker 1: issue is the credit worthiness of the people who need
Speaker 1: it most now. Traditionally, this is an issue that monetary
Speaker 1: policy assumes is going to affect banks. You know, the
Speaker 1: depositors look at the banks, they worry that the banks
Speaker 1: are making loans that are not prudent, and they try
Speaker 1: to withdraw their deposits. Here in some ways it's just
Speaker 1: the opposite. The banks have tremendous amounts of money, but
Speaker 1: they're worried about the credit worthiness of the restaurants and
Speaker 1: bars and taxi businesses that right now, for practical purpose
Speaker 1: as are shut down. So UM many companies are simply
Speaker 1: looking at whatever can trade, whatever might be liquid. So
Speaker 1: it's really monetary policy and UM the ideas around liquidity
Speaker 1: that apply here, and those have dominated any idea of
Speaker 1: the ability to UM call relative value. I want to
Speaker 1: get more into some of the ways monetary policy can
Speaker 1: help this crisis, including again some of the things that
Speaker 1: we're just announced this morning, but before we do, I
Speaker 1: just want to sort of go back to this idea
Speaker 1: of historic grab for any cash that people have, the
Speaker 1: likes of which maybe we've never seen before or very
Speaker 1: rarely seen. One of the things that's really striking is
Speaker 1: in the last couple of weeks, how treasuries, which are
Speaker 1: almost cash, like the sentence that they're completely backed by
Speaker 1: the full faith and credit of the government, counterparty risk free,
Speaker 1: even those started get selling off, started to be sold
Speaker 1: off a little bit because if we think right like this,
Speaker 1: like hierarchy of money, Yeah, holding a treasury is really
Speaker 1: great for you know, lean times and you want to
Speaker 1: be saved, but if you need to make a bill
Speaker 1: payment tomorrow, you still just want cash instead. Correct. Yes,
Speaker 1: So in the treasury market, um there has been surprising
Speaker 1: amounts of illiquidity. Usually in the treasury market, liquidity comes
Speaker 1: in a couple of tiers, and the most liquid tier
Speaker 1: is the most newly issued notes or bonds, and those
Speaker 1: still seem to be maintaining liquidity. But then the older
Speaker 1: notes and bonds have lost um surprising amounts of liquidity,
Speaker 1: and there have been very large leveraged treasury portfolios. Traditionally,
Speaker 1: those portfolios would have reached through the broker deal or
Speaker 1: bank network for financing. They may have used repo or
Speaker 1: other forms. Many of the balance sheets that normally would
Speaker 1: lend to them have been limited in their ability to
Speaker 1: expand credit. So, among other things, this starts to get
Speaker 1: at some of the core competitive advantages or disadvantages of
Speaker 1: some of these investment platforms. The leveled players really don't
Speaker 1: have any source of funding on their own. Banks now
Speaker 1: have sources of funding. Traditionally they have sources of funding
Speaker 1: through their deposit base. Now the FED and other central
Speaker 1: banks around the world are flooding the bank system with money.
Speaker 1: But some of the post crisis rules on UH the
Speaker 1: proper ratios of debt to equity, and other issues limit
Speaker 1: the ability of banks to lend endlessly, and that has
Speaker 1: partly constrained the system, and it's led the FED, I think,
Speaker 1: at times, to struggle with what it's supposed to do next. Yeah,
Speaker 1: So you had a bunch of these levered funds that
Speaker 1: were effectively picking up pennies in front of a steam
Speaker 1: roller for years by exploiting the difference between the more
Speaker 1: liquid futures and the cash US treasuries, and then that
Speaker 1: trade blew up rather spectacularly a week or two ago,
Speaker 1: and then that ended up infecting the U S treasury
Speaker 1: market and causing all sorts of problems. Uh. Just pass
Speaker 1: forwarding to today again, Monday March, just before we started
Speaker 1: recording this, the Federal Reserve announced its latest attempt to
Speaker 1: soothe the market, and that includes potentially unlimited QUEI and
Speaker 1: also some help for companies and munies. Steve, I know
Speaker 1: you've been thinking a lot about this, but is this
Speaker 1: the right thing for the FED to do? Are they
Speaker 1: on the right track or would you be encouraging to
Speaker 1: do something else at this point? Well, probably the most
Speaker 1: important thing the FED did this morning was announced a
Speaker 1: couple of new facilities that allows the FED to buy
Speaker 1: a much wider range of assets directly from investment portfolios
Speaker 1: and businesses, so this is now no longer limited to
Speaker 1: the typical um set of primary dealers. They announced the
Speaker 1: term Asset Lending Facility, which basically will buy all kinds
Speaker 1: of asset back securities as long as they have the
Speaker 1: proper ratings, and they will buy those securities from any
Speaker 1: eligible um US portfolio. They also announced a series two
Speaker 1: programs directed at the corporate market, one that will buy
Speaker 1: corporate debt directly from US companies with headquarters in the
Speaker 1: United States and doing major business in the United States.
Speaker 1: So this effectively creates a direct connection between investment grade
Speaker 1: companies and the government balance sheet. They announced similar programs
Speaker 1: for secondary corporate debt, and they expanded the program that
Speaker 1: they announced a week ago for commercial paper. So the
Speaker 1: FED is slowly stepping in the direction of trying to
Speaker 1: address this cascading illiquidity across these markets. And my guess
Speaker 1: is these new programs for ingressment investment grade paper will
Speaker 1: have um a tremendously good effect and should start to
Speaker 1: eliminate some of the volatility. So just to help people understand,
Speaker 1: it's not that, you know, we're still going to have
Speaker 1: these sort of main street economic crisis for as long
Speaker 1: as people are locked down, as long as the virus
Speaker 1: is here and so forth, and that's going to continue
Speaker 1: to ravage the economy. But in the meantime, high quality
Speaker 1: companies can at least ease up theoretically a little bit
Speaker 1: on grabbing hold of any cash that they can in
Speaker 1: the system, because for not for the moment, the FED
Speaker 1: will backstop essentially their short term borrowing. So that should
Speaker 1: the idea is that eases some of the overall desperation
Speaker 1: that every person in every company everywhere has for liquidity. Yeah,
Speaker 1: exactly right. Investment grade companies, large investment grade companies at
Speaker 1: this point essentially have substantial direct assess to the FED,
Speaker 1: and my guests would be the Fed's going to continue
Speaker 1: providing and expanding that access as long as it sees
Speaker 1: signs of stress. The b S facility starts to walk
Speaker 1: down the path of providing better access to main street,
Speaker 1: and that would have to come through the willingness of
Speaker 1: banks to make credit card loans and auto loans. The
Speaker 1: asset back facility basically has elements that will allow auto
Speaker 1: dealers to finance cars and other vehicles more easily. But
Speaker 1: you still, at this point, I think, have a problem
Speaker 1: getting credit to a lot of smaller mainstream businesses. Maybe
Speaker 1: the FED has a couple of tricks left in the bag,
Speaker 1: but my guess is you're really going to need some
Speaker 1: kind of physical policy. So I wanted to go back
Speaker 1: to something you touched on earlier, which was this notion
Speaker 1: of the dealers or the banks being a little bit
Speaker 1: more restricted in terms of the amount of risk that
Speaker 1: they can take, and maybe some of that risk having
Speaker 1: shifted to the buy side, because a lot of people
Speaker 1: right now are talking about how the current crisis resembles
Speaker 1: not necessarily Lehman Brothers in two thousand and eight, but
Speaker 1: more lt CM or long term capital management. Back in
Speaker 1: they dabbled in a lot of derivatives UH and basically
Speaker 1: exploded UM. So I'm just wondering if if that's the
Speaker 1: right framework to look at the current state of the
Speaker 1: financial industry, and if that's the reason why the FED
Speaker 1: is quite focused on expanding UM the parties that it
Speaker 1: can actually do business with. When it comes to QUEWI,
Speaker 1: the biggest difference between this crisis in two thousand and
Speaker 1: eight is that the crisis in two thousand and eight
Speaker 1: was in the financial system. The crisis in is outside
Speaker 1: of the financial system. UM really at its core in
Speaker 1: corporate America UH, and as a result of corporate America
Speaker 1: being stressed, it's a problem then on main street and
Speaker 1: in households pretty much around the world. The FED as
Speaker 1: a central bank is really really well equipped to pour
Speaker 1: water on fires inside the financial system. Outside the financial system,
Speaker 1: it has to get a little bit more creative, because
Speaker 1: the core issue here is the fundamental credit worthiness of
Speaker 1: main street borrowers and many homeowners. The best possible solution,
Speaker 1: what which was in some material within the last few
Speaker 1: days that I published in Financial Times, is to provide
Speaker 1: government guarantees of emergency bank loans to otherwise credit worthy businesses.
Speaker 1: We have a problem that the economies of ground to
Speaker 1: a sudden stop, but I think it's widely expected that
Speaker 1: after a ninety or a hundred and eighty day period,
Speaker 1: many of these businesses will be viable again. So the
Speaker 1: trick is bridging that period by providing credit. Banks I
Speaker 1: think have plenty of money, but I think any banker
Speaker 1: hesitates to lend to a business about to see its
Speaker 1: earnings evaporate. If you had, if you had the government
Speaker 1: provide guarantees, I think banks would have a lot more
Speaker 1: courage in that situation, right, I really Uh. There was
Speaker 1: this great LARRYUS Summers quote that he said a couple
Speaker 1: of weeks ago, and I keep thinking about it. He's
Speaker 1: basically saying, like somehow I forget his working exactly, But
Speaker 1: essentially the challenges how do you freeze financial or so
Speaker 1: how do you freeze economic time, while uh, financial time
Speaker 1: continues in its current state, and this idea is like, Okay,
Speaker 1: everyone knows we have to stay inside. Everyone knows that
Speaker 1: there are a lot of viable businesses that will need
Speaker 1: to shut their doors for days or whatever. But the
Speaker 1: bills keep coming in regardless and essentially and as you say,
Speaker 1: that sort of outside of the monetary system and subside
Speaker 1: of the banking system per se. So it's somehow going
Speaker 1: to have to be an Act of Congress to come
Speaker 1: up with a solution that lets everyone pay their bills
Speaker 1: during the essential time of the FACTI lockdown. Yes, that's
Speaker 1: exactly right. So, Steven, I wanted to get to your book, uh,
Speaker 1: and we spoke a little bit about it earlier. But
Speaker 1: you know, when people talk about investment strategy, they're usually
Speaker 1: treating all the investors in a sort of similar way.
Speaker 1: But as you point out, people tend to do things
Speaker 1: differently according to their competitive advantages. Could you maybe just
Speaker 1: walk us through, uh, the premise of your book and
Speaker 1: why this was something that interested you. Yeah. Absolutely. I
Speaker 1: think that when you sit in a seat like mine,
Speaker 1: where you're really advising a wide range of investors, you
Speaker 1: start to see over time that the players matter just
Speaker 1: as much as the market does when it comes to
Speaker 1: UM investing. You can UM look from banks to insurance companies,
Speaker 1: mutual funds to hedge funds, reets, sovereign wealth funds. They
Speaker 1: all operate UM with very very distinct advantages and disadvantages,
Speaker 1: and those kinds of things not only shape what they
Speaker 1: buy how they use the as assets, but UM it
Speaker 1: also ends up turning around and affecting the value of
Speaker 1: those assets in the marketplace. And they're just plenty of
Speaker 1: examples of that, including the kind of markets that we're
Speaker 1: looking at right now. And UH I thought for years
Speaker 1: that we needed something that went through these different kinds
Speaker 1: of investors and talked about what their strengths and weaknesses
Speaker 1: might be and how it affected assets. And that's what
Speaker 1: led me to write the book to expand this further
Speaker 1: strengths and weaknesses of different types of assets. What does
Speaker 1: that mean specifically, Well, I'll give you an example. It's
Speaker 1: very relevant to where we are now. UM. Let's take
Speaker 1: UM source of funds. Some investment platforms just have tremendous,
Speaker 1: tremendous advantage in the variety and the low cost of
Speaker 1: their funding. And for example, right now, the the eight
Speaker 1: hundred pound guerrilla on that front is the banking system.
Speaker 1: So banks traditionally have a really wide range of sources
Speaker 1: of funds through their retail deposit base. Some of their
Speaker 1: retail deposits are a kind of fast deposits from big
Speaker 1: corporations that are moving money through their accounts quickly. Other
Speaker 1: other deposits are very very long, steady and stable UH
Speaker 1: sources of funds. Like, for example, if you look at
Speaker 1: my checking account, I've probably had some at least minimal
Speaker 1: balance in my checking account for decades, So banks could
Speaker 1: use my money that's there for decades, your money that's
Speaker 1: there for decades, other people's money that may be there
Speaker 1: for far shorter periods of time, corporate money which may
Speaker 1: come in and out day to day, and they can
Speaker 1: use that to buy or fund a wide range of
Speaker 1: not only loans, but securities. If you want to go
Speaker 1: to the opposite extreme, you could look at hedge funds,
Speaker 1: for example, or reads, which usually borrow based on repurchase
Speaker 1: or repo agreements UH, and those repo or repurchase agreements
Speaker 1: often last only for a day and have to be
Speaker 1: renewed every day. Right. That leads those kinds of organizations
Speaker 1: kinds of investors highly subject to markets where suddenly there's
Speaker 1: a run on liquidity, and those are the those are
Speaker 1: the folks that are struggling at this point, right, some
Speaker 1: of them would have done that levered US treasury trade
Speaker 1: that we just described. So I guess the question is
Speaker 1: knowing that you have that sort of short term day
Speaker 1: to day funding, shouldn't that change the way you invest
Speaker 1: potentially or at least the way that you hedge. Absolutely? Um.
Speaker 1: I mean when it comes to the way you invest,
Speaker 1: and you see this in the portfolios at least most
Speaker 1: of the portfolios of prudent leverage investors, that almost forces
Speaker 1: you to hold highly liquid assets. So does it make
Speaker 1: sense to have levered portfolios of treasuries? Um, Yes, it
Speaker 1: probably does. Would it makes sense to have leveraged portfolios
Speaker 1: of agency mortgage backed securities? It probably does. Would it
Speaker 1: make sense for you to have leveraged portfolios of less
Speaker 1: liquid assets like um certain forms of a corporate debt
Speaker 1: or loans that may not be easy to sell on
Speaker 1: short notice. Once you start leveraging less liquid assets, you
Speaker 1: begin to take much more risk uh of a liquidity
Speaker 1: crunch of the sort that we're in now, and what
Speaker 1: you can see is that in today's marketing current circumstances,
Speaker 1: lever portfolios of the most liquid assets have been able
Speaker 1: to delever, not necessarily um in a pretty fashion, but
Speaker 1: nevertheless they've been able to de lever, while levery portfolios
Speaker 1: of less liquid assets have struggled, and at times I
Speaker 1: think some of those organizations have been on the brink
Speaker 1: of failing to meet calls for additional margin, additional cash
Speaker 1: and could go out of business. So a lot of
Speaker 1: this I think makes sense to people right now. I mean,
Speaker 1: we're looking in a market that's been you know, arguably
Speaker 1: some of the most most volatile, complete turmoil that many
Speaker 1: people have ever seen in their careers. But you know,
Speaker 1: like in the normal times, you know, two thousand thirt
Speaker 1: was there, Just like, how do you get this message
Speaker 1: across and how do you deal with the issue that
Speaker 1: I was sort of talking about at the beginning, where
Speaker 1: prior to right now, the dominant strategy for an investor
Speaker 1: would essentially just be too go all in on high
Speaker 1: baya or short volatility or just that that historical correlations
Speaker 1: UH will maintain, Like how do you how do you
Speaker 1: apply these lessons to non crisis periods and be a
Speaker 1: competitive investor. Well, for example, if we we step outside
Speaker 1: the current situation, taking insurers for example, UM, I know
Speaker 1: it probably is not the usual way people think about
Speaker 1: insurance companies, but when you hand when you pay your
Speaker 1: UH life insurance bill or your auto bill, in many cases,
Speaker 1: you're really handing those insurance companies a dollar that at
Speaker 1: some point in the future they're going to hand right
Speaker 1: back to you. I mean, an auto UH policy is
Speaker 1: probably the simplest. You don't expect to be in an accident,
Speaker 1: but if you are fender bender or otherwise, the auto
Speaker 1: companies are going to pay to get your car fixed.
Speaker 1: You you could have held that dollar in your savings account,
Speaker 1: but instead you're giving it to the insurance company, and
Speaker 1: the insurance company gives it back to you. Between the
Speaker 1: time you give it to the insurance company and the
Speaker 1: time that company pays it back to you, it has
Speaker 1: the opportunity to invest in a wide range of assets.
Speaker 1: So with life insurance companies, especially since the time between
Speaker 1: getting the dollar and paying it back is so long,
Speaker 1: life insurers are just beautifully equipped for owning illiquid assets. UM.
Speaker 1: They can hold loans of wide range, they can hold
Speaker 1: securities that are private play easements instead of public securities.
Speaker 1: They're able to invest in real estate, where the return
Speaker 1: to the investment really requires a long horizon and the
Speaker 1: ability to tolerate potential swings in prices. If you were
Speaker 1: running a mutual fund, in contrast, it would be very
Speaker 1: difficult to hold securities that have limited liquidity. That's because
Speaker 1: a mutual fund has to provide daily returns to their shareholders.
Speaker 1: So just if you look at funding, and then you
Speaker 1: look at other aspects of these platforms, like how the
Speaker 1: accountants measure these things, some are really well equipped to
Speaker 1: hold the liquid assets and others aren't well equipped. You
Speaker 1: can see that in a bunch of other dimensions as well.
Speaker 1: Where do you see the most extreme liquidity mismatches in
Speaker 1: the current sell off? Is there something specifically that you're
Speaker 1: um that you're watching out for. Well, in this setting,
Speaker 1: the place you always have to look first are the
Speaker 1: most highly levered investment portfolios as well as the most
Speaker 1: highly levered corporate balance sheets, and both of those markets
Speaker 1: are struggling, both of them. Um. So, we've heard reports
Speaker 1: over the last couple of days of large hedge fund
Speaker 1: portfolios that are circulating and looking for bids. We've heard
Speaker 1: of um significant demands for liquidity from real estate investment trusts,
Speaker 1: which also tend to be leveraged. And you can clearly
Speaker 1: look at the corporate world, to some extent investment grade,
Speaker 1: but very very clearly in the leverage loan market, where
Speaker 1: corporations are drawing down their credit lines and trying to
Speaker 1: fortify their balance sheet for periods of you know, really
Speaker 1: difficult earnings ahead. Those are the places I think that
Speaker 1: are right now most at risk, and we're seeing that
Speaker 1: they'll they'll pay for liquidity at almost any price. How
Speaker 1: do you identify opportunities though, because you know it's really
Speaker 1: bad right now, it also looked really bad a week ago,
Speaker 1: And if you try to be here, I said, okay,
Speaker 1: I'm gonna be the liquidity provider. You know, I'm gonna
Speaker 1: be the liquidity provider that jumps into the panic. And
Speaker 1: you said that a week ago you might already be
Speaker 1: you might already be finished, you might already be taken out.
Speaker 1: So how do you think about risk management and exploiting
Speaker 1: these opportunities where people will pay almost any price for liquidity,
Speaker 1: but not blowing up yourself in the process By mistiming. Well,
Speaker 1: So if I started with these investment platforms, the strongest
Speaker 1: players in the market are going to be the ones
Speaker 1: with the most capital um, the deepest and lowest cost,
Speaker 1: and widest variety of funding. Those are the places that
Speaker 1: are going to have the strong hand. You might think
Speaker 1: that that would include banks, and to some extent that
Speaker 1: might be true, but regulations limit the degree of credit
Speaker 1: risk that banks can take, so while they have great
Speaker 1: advantages in capital and funding, have some disadvantages in regulatory constraint.
Speaker 1: Insurers are also likely to be in a strong position,
Speaker 1: especially insurers that have strong capital and deep access to funds.
Speaker 1: So that would probably include most of the larger players
Speaker 1: and some of the players that are using the investment
Speaker 1: grade bond market to raise cash at this point. I mean, notably,
Speaker 1: you've seen Berkshire Hathaway in past crises right to the rescue,
Speaker 1: and although that clearly reflects the genius of war and Buffett,
Speaker 1: there is no doubt at all, it also reflects the
Speaker 1: strength of the insurance balance sheet that he's playing off of.
Speaker 1: So those are the those are the strong platforms. Those
Speaker 1: platforms have the ability two buy assets that otherwise would
Speaker 1: be in free fall, they're not subject to usually to
Speaker 1: margin calls. Um, they're accounting rules are very very kind
Speaker 1: two assets that show price volatility. So what we've been
Speaker 1: advising investors to do when they have balance sheets like
Speaker 1: that is to buy fundamentally sound cash flows at widespreads
Speaker 1: and those would in flute some government back cash flows
Speaker 1: that are trading at distress levels. And when it comes
Speaker 1: to the corporate market, cash flows from corporations that have
Speaker 1: adequate liquidity to weather the next three to six months
Speaker 1: and have the potential to come out of this crisis
Speaker 1: potentially stronger than when they went in. And those would
Speaker 1: be the kind of investments that right that we've been advising.
Speaker 1: So then you don't have to be a hero. It's
Speaker 1: not really about timing the bottom or anything like that.
Speaker 1: Or this fell another ten percent after I bought it,
Speaker 1: but take there are looking for opportunities in which the
Speaker 1: spreads are so wide and the sort of uh predictability
Speaker 1: of future cash flows for whatever reason, as you mentioned,
Speaker 1: something like our insurance et cetera, are so consistent that
Speaker 1: your your margin for error is quite large. Yes, I mean,
Speaker 1: timing might be everything in comedy, but most research shows
Speaker 1: that it doesn't really amount to much in investing. So
Speaker 1: if you look at some of these stronger balance sheets,
Speaker 1: they are going to be able to absorb these assets
Speaker 1: and honestly um provide good returns to their shareholders for
Speaker 1: years and years to come. Right, Stephen, we really appreciate
Speaker 1: you coming back on the show, and we're definitely gonna
Speaker 1: look out for your book when it comes out and
Speaker 1: equal thanks so much, great, Thanks Tracy, Thanks Joe. Thanks
Speaker 1: that was great. Joe. I was just thinking, uh, Warren
Speaker 1: Buffett has actually been notably absent from the recent sell off. Yeah, right,
Speaker 1: like we have yet to see uh an op ed
Speaker 1: from him in the New York Times saying, the buy
Speaker 1: American I am, and I think, and I wonder if
Speaker 1: like everyone is just so shell shocked, what does that
Speaker 1: just maybe that includes Warren Buffett? Like the degree of uncertainty.
Speaker 1: I mean I don't know, like I mean, I don't
Speaker 1: know like what what he's thinking, but like the degree
Speaker 1: of uncertainty here at the sort of path dependency and
Speaker 1: the speed with which things can fire, a lot of control.
Speaker 1: I mean, like look in two thousand and two thousand nine,
Speaker 1: we always knew there was a we didn't know that
Speaker 1: they were going to get there, but it was you know,
Speaker 1: as our guests was talking about, it was a monetary phenomenon,
Speaker 1: was a crisis of the banks. And you can theoretically
Speaker 1: always paper over a monetary phenomena, but when you have
Speaker 1: a real economic crisis where you like really do not
Speaker 1: know how long it will be before people are comfortable
Speaker 1: spending money in retail establishments, again, I just then the
Speaker 1: degree of uncertainty and the desire to hoard liquidity or
Speaker 1: hard cash when you have it. I just think that's
Speaker 1: like what makes this almost feels like incomparable to anything
Speaker 1: we've seen. Yeah, the speed has certainly been unprecedented. And
Speaker 1: even in two thousand and eight in the financial crisis,
Speaker 1: when we were worried about the banking system collapsing, people
Speaker 1: still went out and you know, bought sandwiches or you know,
Speaker 1: like their haircut and things like that. That's just not
Speaker 1: happening in the current situation. So it does raise all
Speaker 1: sorts of questions. The other thing I like about Steven's
Speaker 1: framework in particular, this idea of you know, different investors
Speaker 1: have different ways of funding themselves, different advantages. It's that
Speaker 1: kind of detail that I find a lot of investment
Speaker 1: theory just sort of glosses over, like obviously big investors
Speaker 1: want to buy low and sell high. But actually, as
Speaker 1: Stephen was saying, there's a funding consideration there too, and
Speaker 1: you always want to be sort of matching your funding
Speaker 1: with your investment horizon or the assets maturity. Yeah, it's
Speaker 1: a really it's a really good thing to uh to
Speaker 1: think about right now in terms of like how people
Speaker 1: are thinking about whether there are in fact opportunities in
Speaker 1: this market, right and whether there are vulnerabilities because as
Speaker 1: we've seen, this is sort of so far. I hope
Speaker 1: this doesn't change by the time this episode comes out,
Speaker 1: but so far this has sort of been vindication for
Speaker 1: the regulators. Right. They encourage banks to hold a lot
Speaker 1: of risk to turn out their funding and it's sort
Speaker 1: of paid off in this situation. But the downside, of course,
Speaker 1: is that you have a lot of stuff that's just
Speaker 1: held outside the banking system and might be harder for
Speaker 1: the Federal Reserve and other regulators to actually help. Yeah,
Speaker 1: exactly right. So so far, there's a there's a argument
Speaker 1: to be made that the bank that the post crisis
Speaker 1: regulations have done a good job, because we have yet
Speaker 1: to hear about major concerns with systemically important financial institutions
Speaker 1: because all of the true risk has been pressed out
Speaker 1: so so far, there's definitely a case to be made
Speaker 1: that the regulations are working, as the number of times
Speaker 1: you're saying so far in that sentence's nervous. But yeah, yeah,
Speaker 1: let's hope it stays true by the time this episode
Speaker 1: comes out. Shall we leave it there? Yes? Okay, This
Speaker 1: has been another edition of the ad Thoughts podcast. I'm
Speaker 1: Tracy Alloway. You can follow me on Twitter at Tracy Alloway,
Speaker 1: and I'm Joe Wisenthal. You can follow me on Twitter
Speaker 1: at the Stalwart. And you should follow our producer on Twitter,
Speaker 1: Laura Carlson. She's at Laura and Carlson. Follow the Bloomberg
Speaker 1: head of podcasts, Francesca Levi at Francesca Today, and all
Speaker 1: of the Bloomberg podcasts. You can find them under the
Speaker 1: handle at podcasts. Thanks for listening. Year to e