After an unexpectedly long pause, we resume “The Journey: From Floor Trader to Family Office Manager.” (If you haven’t read Part I, go back and start here.)
In Part IV, Long-Term Transition, we looked at the details of handling a trade, Deep Alpha’s early experience as a hedge fund manager, and the 2008 experience.
Now, in Part V, we look at managing large amounts of capital (hundreds of millions)… moving beyond conventional wisdom… and going global in the search for opportunities.
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And now to Part V…
Note: This interview segment is Part V of a series. Also available:
- Part I: From Floor Trader to Family Office Manager
- Part II: Big Positions On
- Part III: Embracing Market Profile
- Part IV: Long-Term Transition
- Part VI: New Horizons
JACK: Let’s say you have a sum that is far too large to trade liquid markets with. For example, say you had to allocate $800 million dollars. How would you approach that? What would you do with a chunk of change that big? Because to a significant degree, keeping it in cash is a risk too.
DEEP ALPHA: One of the things I’ve done, in the past two-three years, is find some of the best minds I can hire to help me. For example, I have an advisor just for biotech… an advisor for trends in cybersecurity… emerging markets etc… they aren’t someone I talk to every day, but they are people I stay in touch with and source.
JACK: To find best-in-class opportunities?
DEEP ALPHA: Exactly. If I had $800 million to run, I would scale up this process. Keep finding the best of the best, just a lot of homework, and then hiring people to help you do due diligence on all the decisions you make.
JACK: How would you think about allocation in terms of different strategies? For example, “this amount of capital goes for trading liquid markets… this amount of capital goes for large-scale macro opportunities… this amount goes towards real estate, or long-term venture capital,” and so on. How do you even think about slicing that pie up?
DEEP ALPHA: Really great question. When I was first attending these conferences, and listening to how huge endowments and big family offices do this, we would have private breakfasts without the brokers and go over the allocation decisions. From a trading perspective, I was always amazed how vanilla these portfolios were.
JACK: You mean like the standard 60/40 mix of stocks and bonds, stuff like that? GE and Coca Cola?
DEEP ALPHA: Yes, though I see that changing now, especially since 2008. I’m starting to hear more “No, I don’t think that’s quite right.” And it was never my approach to do it that way. My approach is to deal with the question from a macro perspective, isolate the areas I think will see growth, and put more money into those areas. That is how I do it.
JACK: One of the things that amazes me about conventional wisdom and typical portfolio allocation, is the way that so much money was thrown at stuff that had a lot of embedded risk, but not a lot of upside return. Just middle-of-the-road investments with no great potential, but a non-negligible chance of disaster.
If you buy General Electric, for example, maybe you’ll make 3 to 5 percent compound returns over X years and so on… but on the downside, maybe GE Capital blows up and you take a huge haircut. The reward to risk seems all out of whack. What always made more sense to me, was what Taleb sort of described as the risk barbell strategy: Put some capital into a class of opportunities that are more aggressive and speculative, but that give you that major upside, and then other holdings that are absolutely safe, with as much risk stripped out as possible.
I find it fascinating how that whole world was forced into violent change post-2008, being aware of just how much embedded risk the old ways carried. What are some of the vibes and psychological observations you’re picking up from wealthy families and managers in this post-2008 world? Are they scared? Excited? Pensive?
DEEP ALPHA: Again a great question. The initial feeling was a strong urge to just “play it safe.” The managers have boards they have to talk to, and the families just want to preserve capital and still have a legacy.
JACK: Major risk aversion.
DEEP ALPHA: Yes, major risk aversion. That was the name of the game. That and cutting costs, reducing fees on deals they were doing… very much preventative, “How do we set ourselves up to never be in this position again.”
JACK: And what are some of the answers to that? In terms of avoiding a repeat of 2008? Cut down on illiquid asset classes, or…?
DEEP ALPHA: The whole alpha vs beta question was tossed around a lot. And there was sincere acknowledgement among most of them that the Yale endowment model had run into serious trouble.
JACK: People didn’t realize that Yale did well because they discovered the inherent mispricing of illiquid asset classes 10 or 15 years ago, and now, with everyone piling in, those illiquid assets no longer saw a discount and may even have been pushed up to a premium thanks to all the copycats. Classic game theory, all the extra alpha being milked out.
DEEP ALPHA: Exactly. I think even after 2008 they were still just getting their head around it: “Oh, we were late to the game.” And “to look good, we had to go out on the risk curve at the worst time.”
JACK: Getting closer to return-free risk as they reached for yield.
DEEP ALPHA: Right. It was a balance of feeling that hangover after getting burned, but still being in business and still having a need to perform. Like you said, they can’t just go into money markets – and now they have to play catch-up with their losses.
So it’s a cautious dance, on the lines of “Okay, what can we figure out what’s not so risky but gives a workable return, so we can make at least 3 or 4 percent.” Then let’s take some of the portfolio and do some different things.
Believe it or not, there is more talk about esoteric investment ideas now. These are smart people who realize they made some bad mistakes. But they are also very aware of how the globe is changing.. how demand patterns are shifting… they still don’t want to miss out on the next wave, and they are convinced that next wave is coming.
So I would say for sure they have to become much more “macro.” They are asking questions that they never asked before, about the big macro picture and what is going on.
JACK: The need to leave the United States for instance – to go global in the search for opportunities that combine acceptable returns with low risk.
DEEP ALPHA: Yes.
JACK: What does this look like in practice? Financing the construction for rental income properties in Egypt? Buying Turkish bonds when it looks like inflation has peaked? That kind of thing? More awareness of what is happening?
DEEP ALPHA: Absolutely. And seeking out money managers with expertise in particular areas. Not just the broker that says “some into these ETFs” and so on… a lot more specialization, and expertise in that specialized area, on a global scale.
JACK: Would you then say this point in time is a real opportunity for emerging hedge fund managers? And by emerging I mean up and coming, not necessarily focused on emerging markets.
DEEP ALPHA: I think so.