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Capital Allocators – Inside the Institutional Investment Industry
[REPLAY] James Aitken – Macro Strategist Extraordinaire (Capital Allocators, EP.58)
01:26:33
Australian James Aitken is the Founder and Managing Partner of Aitken Advisors, a one-man macroeconomic consultancy based in Wimbledon, England that works with approximately one hundred of the most influential pools of capital in the world. James...
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- [00:02]
Ted Seides
Capital Allocators is brought to you by my friends at WCM Investment Management. To outperform the markets, you have to do something differently from others. In my 30 something years investing in managers, there may be no one I've come across who does that as clearly and as well as wcm. I've seen it up close. As an investor in their international growth strategy for the last five years, WCM is a global equity investment manager majority owned by its employees. They believe that being based on the west coast, away from the influence of Wall street groupthink provides them with the freedom to live out their investment team's core values, think different and get better as advocates of integrating culture research into the investment process and advancing wide moat investing. With the concept of moat trajectory, WCM has delivered differentiated returns while building concentrated portfolios designed to stand out from the crowd. WCM is committed to defying the status qu by dismantling outdated practices, believing in the extraordinary capabilities of its people, and fostering optimism to inspire each individual to become the best version of themselves. To learn more about WCM, visit their website@wcminvest.com and tune into this slot on the show to hear more about WCM all year long.
- [01:27]
This testimonial is being provided by Ted Seides and Capital Allocators who have been compensated a flat fee by wcm. This payment was made in connection with Capital Allocators testimonial and production of podcasts and is not depend on the success or level of business generated. The opinions expressed are solely those of Capital Allocators and may not reflect the opinions of others. Investing involves risk, including the possible loss of principle. Past performance is not indicative of future results. Please visit wcminvest.com for WCM's ADV and further information.
- [01:51]
Capital Allocators is also brought to you by Morningstar. What if data wasn't just a bunch of raw numbers, but a clear and decisive language to help connect investment strategies with long term investor needs in a constantly evolving market landscape. Morningstar created that language bringing order and utility to insight rich data so you can prepare for your next opportunity no matter the asset class or Market. Visit wheredataspeaks.com to see what Morningstar Data can do for you.
- [02:33]
Hello, I'm Ted Seides and this is Capital Allocators. This show is an open explanation exploration of the people and process behind capital allocation. Through conversations with leaders in the money game, we learn how these holders of the keys to the kingdom allocate their time and their capital. You can keep up to date by visiting capitalallocatorspodcast.com My guest on today's show is Australian born James Aitken, the founder and Managing Partner of aitken Advisors, a one man macroeconomic consultancy based in Wimbledon, England, works with approximately 100 of the most influential pools of capital in the world. James started his career in 1992 as a foreign exchange trader, moved to London in May of 1999 and in March 2002 joined the infamous AIG Financial Products team in London. In August of 2006, two years before the crisis hit, he joined UBS where he deployed his knowledge of the inner workings of the financial system to help his institutional investor clients successfully navigate their portfolios through 2007 and 2008. At the urging of those clients, James established his own firm in June 2009. Our conversation covers James perspective on the global financial crisis from his seat at its epicenter, the eurozone crisis in 2011, subsequent process driven opportunities in Greece, views on central banks in the us, China and Europe, some brief observations on India, positioning for the current environment, and a great macromanager before we get going, I'd like to invite you to join the Capital Allocators Think Tank, a premium content subscription service where you can discuss each episode with me and the guests alongside allocators of sizable pools of capital. You'll also gain access to the library of transcripts of past episodes. Visit capitalallocatorspodcast.com and click the Premium Content button to sign up. Thanks for your support. Now, you may have visited the site and noticed a lofty sticker price for the premium service. We've had some nice early traction from some high quality organizations, but I quickly realized that many of you would like to participate as individuals. I'm excited to announce that we've added an individual premium subscription to go along with the existing corporate rate. You can visit the site to see pricing and terms and conditions. Please enjoy my enlightening conversation with James Aitken.
- [05:13]
James Aitken
James, it's great to see you.
- [05:14]
Thank you, Ted.
- [05:15]
Well, there's a lot we're gonna talk about. I think we'll see what happens.
- [05:20]
I wish you luck in editing this.
- [05:21]
Ted Seides
Why don't we start with how you.
- [05:24]
James Aitken
Got started in this?
- [05:25]
I think it was almost an accident. I never had any inclination to get into financial markets, but my father was and actually still is at the age of 81, a very good Australian value investor. So there was a little bit of financial markets and investing DNA there somewhere. But it wasn't until I was at university that I thought, okay, I'll Make a go of that and work from a quarry bank in Sydney and foreign exchange and so forth. But I'll spare you the sad tale of my lamentable sell side career. I think we're cutting to the chase is how did I end up running my own business for the past nine years? And you know, rather lucky than smart. And unfortunately we have to get into my experiences as an employee of AIG Financial Products.
- [06:05]
Yeah, the infamous AIG Financial Products.
- [06:07]
Thanks, Ted, that's very good. Very kind of you to remind everybody of that, but. But as you do when you're 31 years old, you think you're well read and you know a bit about the world. And I started working for, believe it or not, the very vanilla trading business of AIG which was commodities and foreign exchange in early 2002. And obviously this is in London. And if anyone listening is in doubt, yes, I'm Australian and I started hanging out with these two extraordinary men who were working at AIG Trading. One was the late Sir Alan Walters, who was Margaret Thatcher's economic adviser. And the other was a very dear friend of mine, Bernard Conley. Well, he's still a dear friend. And I realized, Ted, that far from being well read and knowledgeable at the bright old age of 31, that as I was hanging out with these two extraordinary men, I knew nothing about everything that mattered. And that's quite a humbling recognition.
- [07:04]
Was there a moment early on where that aha moment came?
- [07:08]
Oh, I think it was in about the second meeting I took with Bernard and Sir Alan at all these references to philosophy and psychology, psychology and history and economic and history and you know, not just Road to Serfdom type stuff or Keynes, but all these other references and historical perspectives that frankly I knew nothing about. And that's when, I mean, I've always been a very keen reader. But that's when I said, right, I've got to ramp this up. And my objective over the next couple of decades is to try to catch up to where these men are today. So it was a whole series of epiphanies, if you will. And then things got a bit lively in 2003 because Joe Cassano, who obviously we know was running AIG Financial Products, he took over AIG Trading. And as luck would have it, I was one of the employees of AIG Trading that Joe kept on. And I found myself working in that quite extraordinary dealing room in Curzon street in Mayfair. Still get the tremors when I walk past it to this day. But it was again a humbling Experience. And I thought I knew a little bit about markets. And the irony and perhaps tragedy with the benefit of hindsight of AIG Financial Products was that it was obviously opaque to the rest of the world because no one quite knew what was happening in the firm. But internally, I could walk 10ft across the room all sweet and innocent and say, can you please explain to me what you're doing with that subprime insurance and how that CDO works and what do you mean by collateral and what's this counterparty risk and how come you're underwriting 29.7 billion euros of Dutch mortgages at 10 basis points? I don't quite understand that. So I kept my head down for four years. Didn't understand much, in fact, anything of what I was picking up. But I started to keep a notebook to write things down that I heard. And I thought, right, I've got to try and understand what that means. And of course, one, I mean, there's many examples, but I think one key One was when AIG was first downgraded, I think it was 2005, and I started to hear whispers for more seasoned long term employees of AIG Financial Products along the lines of, oh, gosh, if we downgraded another couple of notches, there's not enough collateral in the world to make us work. And Ted, I had no idea what that meant, but I thought, right, I better find out. So look, I managed to stay out of trouble until the summer of 2006, by which time, as it emerged, Joe Cassano had been informed that, look, Joe, there's some things we're doing here that are turning out not quite as we expected. We need to be careful. I was hired by ubs, and again, how lucky was I to be employed by UBS on a foreign exchange sales desk in London? And they were kind enough to say, look, you have this expertise about other stuff from AIG financial products, you're not just an FX guy. UBS has this enormous toolkit. If you want to transact other products on behalf of your clients or advise your clients about, guess what, ABX, subprime indices and all these other things subject to compliance approval, you're free to do so. Wow. And off we went. Of course, the irony was that UBS had an awful lot of exposure to this kind of kit as well. But Ted, I started giving presentations from September 2006 onwards to various institutional investors around the world on what would happen if house prices stopped going up and what was happening under the surface or as people know it now. The Plumbing how things work, how balance sheet works, liquidity puts counterparty risk, collateral, all the moving parts of the financial system. The premise was if house prices stop going up, we got a problem because the whole structured credit machine could grind to a halt and if there's ever a mark to market event, look out because the whole system could grind to a halt because of all the connectivity and suffice to say it was a bit of an uphill battle to explain to clients and I should add policymakers around the world Starting from late 2006 onwards what was happening. And I know this will sound uncharitable, but it's true. It's very difficult to get a man to understand something if his salary or management fees depend upon him not understanding it. Right. Incentives, incentives, there you go. There's a great book to be written on incentives, isn't there? Cialdini did us all a favor with influence, but I want someone to write a book on incentives because everything will become so clear. So there I am sitting in this catbird seat with a front row seat at the circus. Now that's, I think that's actually mixing metaphors. Let's just say I had a front row seat at the circus, right? And how lucky was I? And I keep saying it, but it's true. I worked at the institution that was at the epicenter of so much that was going wrong or did go wrong in 0708 and that was AIG Financial Products. It's a miracle.
- [11:51]
You mentioned that you had these questions as they came up.
- [11:54]
Ted Seides
Were you able to talk to people.
- [11:55]
James Aitken
And get satisfactory answers to those questions at the time?
- [11:58]
No, because as emerged subsequently, AIG Financial Products was not, not the culture where you question things too intensively that was most sternly discouraged. But I did dig and I knew enough. And then to be fair to my wonderful colleagues at ubs, most of whom I'm friends with to this day, I was able to connect dots that I was unable connected AIG Financial Products by getting to know the repo guy who's now my long suffering golf partner or the guy who was making managing counterparty risk or collateral or all these kinds of things. And it all started to fit together. And to give a tangible example, I mean I think we've. Look, we're talking about events of 12 years ago, Ted. But these subprime indices, remember this ABX HE 0602BB minus and boy did it turn out to be triple B minus. And for a long time that index traded to par. Then one day I think it was the second week of 2006. There was a tremendous seller here in New York, the Triple B minus all the way through until September 06 it was trading at 100. And then one day it cracked and it closed below 100. That was the first hint that the CDO machine was somewhat satiated in terms of their subprime bid. Then just to provide another tangible example of what was happening and how important it was to understand how things work the summer of 2007 there's this mythology around August 2007 is when it all booted off, which is I think just not correct. You think about the end of the first quarter, start of 2Q07 Merrill lynch tries to make a margin call on Bear Stearns Asset Management. Now as we may found out in the next couple or we're starting to find out here in 2018, price discovery at the end of a tremendous liquidity and credit cycle can be an awkward moment. So my Merrill Lyn calling for margin for Bear Stearns Asset Management who didn't have it, the emperor had no clothes. And then in July 2007 the rating agencies downgraded the tranches of the CDOs. And I know this might sound a bit complicated but the CDOs were non mark to market vehicles unless and until they were downgraded. And once they were downgraded it was price discovery free for all. And that was the end of it. That was the point of no return. And we can talk about August, we can talk about how central banks even at that point had no clue what was happening. And then we get to Bear Stearns in May 2008. No, no, it was entirely mechanical. It was almost preordained as soon as US house prices stopped going up. And I'll just make a broader observation that when, when you falsify the key assumption underpinning any liquidity or credit cycle you get mean reversion and then some. And it's the lesson of subprime in 0678 it's the lesson of the Eurozone crisis which guess what we might have to talk about as well.
- [15:10]
I think we'll get there.
- [15:10]
Yeah. If I think about the present day, the key assumption underpinning the constellation of asset prices on my Bloomberg is that long term interest rates can never go up, which means that discount rates can never go up much. Which means the net present value of cash flow producing assets today is quite high.
- [15:31]
So you're at UBS through the crisis. At what moment did you set out on your own. And how did that happen, Ted?
- [15:38]
It was entirely by accident, I have to say, the idea that I'm doing what I do today and doing things like this, it's just absurd. It is totally absurd. I mean, the idea that I'm a classic case of eldest child syndrome, totally risk averse. I'm always the kid that had to be on time, have his shoe polished. I mean, not a risk taker at all. And look at me. It's preposterous, right? And I got to work with more and more people at ubs, really interesting investors. And look, as you can tell from what we were discussing before, I was able to help a lot of people in 2007 and 2008 not lose money. And I was also able to help some people make a lot. And towards the end of 2008, where I was very lucky to have a job, many friends being ejected and disappearing, and there I was employed the greatest intellectual exercise of all time, the greatest, if not challenging, but certainly the greatest financial education of all time in terms of what's important. And eventually a couple of young fellows said to me, look, come and have a chat with us in New York. And I'd had people approach me and offer me jobs. I had one sovereign wealth fund say, oh, we'd like to give you a billion dollars to manage a long, short financial fund. And I said, well, that's great, but I can't do that. I don't even know what to do. I couldn't even construct. It's just not me, but thanks very much. And eventually these two young guys out of New York said, look, we've got you back. Set up your own business. We're your first client. I'm like, whoa, now, it only took me four months to make up my mind, right, right. Look at me, Mr. Risk Averse. But that gave me the confidence to resign from ubs. And off I went.
- [17:19]
And what was the intent of what you were going to set up?
- [17:22]
The intent was to help investors of all kinds understand how things work. That was the premise. And as you know so well, you know, you can start with all these whiz bang ideas and slogans of what your business is, but guess what? You learn. So the first premise was, can my young family and I be at least as comfortable as we are today by having a go at this? And the answer was, yes, we can. So let's do it. And my wonderful wife was so encouraging, and I think I'll paraphrase, but I think it was roughly, what have we got to lose? And that's what you need, right? You need that domestic support, right? And I was very lucky there too. But and here's the amusing bit. So I had a spreadsheet of all these people who'd been receiving my inverted commas insights during the crisis. And I divided my distribution list into people who were a slam dunk to sign up for Aitken Advisors LLP on day one. People who were 50, 50 and then people who were no chance at all. And guess what? I start on day one and nearly the entire client base as people I had bracketed is never going to sign up. It just goes to show. It just goes to show. But, but look, I was very. I got to work with extraordinary people, I got to connect with extraordinary people. And of course, by the time I finally kicked off on June 1, 2009, the world had changed. The bottom was in. And it was a very tricky time. You know, you sit there at 1 o'clock in the morning looking at a spreadsheet thinking, what the heck have I done? I'm out of my mind. The world's changed. I'm still writing about all this plumbing and balance sheets. It doesn't matter anymore. The fire brigade has arrived, the fiscal taps are on, the Monet taps are on. Who cares about counterparty risk or collateral? It doesn't matter. So I'm sort of digging a hole. I'm publishing every day, traveling but loving it. And still clients are dribbling in and they were so good to me, they said, ja, don't worry about it, don't worry, just do your thing. You gave us such support during the crisis. Just get after it, mate. We got your back. I mean, how wonderful is that? And then we get to November 2009 and the Germans in their infinite wisdom, decide to make an example of Greece. And I'm going to use that word again, as luck would have it, at AIG Financial Products in London in the summer of 2005, when the Greeks announced that they would include the black economy in their overall GDP statistics, we can't have smelt a rat. It was the most unusual thing to do to meet your debt to GDP obligations. We went through all the documentation, all the derivative documentation, all the counterparty documentation, securitization documentation, not just in Greece, but across peripheral Europe, all the fine print, and guess what? We get to November 2009 and it's all in play. And it comes back to that basic premise. When you falsify the key assumption underpinning any liquidity or credit cycle, you get mean reversion and then some. And the key assumption underpinning economic and monetary union, in fact, to this day, there's no default risk in peripheral credit of all kinds, whether it be sovereign or bank or whatever. And Ted, the Germans thought, here's an opportunity to teach everyone a lesson. And they hit a red button that took economic and monetary union to the brink. And you knew that as soon as they injected a risk premium into Greek sovereign bonds and counterparty risk and haircuts and everything else, they would start a process that would cause tremendous distress and dislocation, not just across economic and monetary union, but across, as we saw from time to time, the entire financial system. What an error. It was an opportunity for me to explain in simple terms this is what is happening, this is what they have done. They have started something that's going to be awfully difficult to control. So stand back, be careful, think about your counterparty exposure to European banks. Think about your exposure to Euro. Just, just be careful. Right now, of course, there were people out there that took advantage of it and said, I'm going to short this, I'm going to buy peripheral sovereigns, you know, the usual stuff. But there's a big, big takeaway from all of this that I think is really important. From November 2009 until whatever it takes from the Draghi wizard in July 2012, we had mistake after mistake after mistake. And it's no secret that European policymakers, broadly speaking, have no strong like of Anglo Saxon capitalism and these things called markets. You know, not very, not very nice people. But when you step back from it and think about who did best from that Eurozone crisis, or dare I say the first Eurozone crisis, it was investors with a broad mandate who understood what was happening, were smart enough to step back from their exposures without wanting to change their mandate, without wanting to change their process, and suddenly become a currency guy or a credit guy. But they did their homework and said, right, we understand what it is, we want no part of it, but we're just going to step back and avoid the worst of it, which is very smart and very disciplined. Which brings us to the restructured Greek bonds. And this is the most brilliant lesson in the importance of culture. Dare I say, you and I have encountered a few hedge funds and other institutions where the founder tends to dominate discussions. That's fine, that can work well. But all the best fund managers I know instill a culture of collaboration where everyone from the intern to the founder to the CIO is encouraged to speak up if they spot something and they Create a collaborative, inclusive culture. And it's easier said than done. And let's just set the scene. Here we are in Manhattan and it's April 2012, and finally they've decided to restructure Greek sovereign debt. And a young lady speaks up at the morning meeting. I'm going to paraphrase only slightly to protect the people involved, but they're friends of mine and it's a brilliant example of how to think and not to react, but how to think and be reflective. And this young lady speaks up in the morning meeting and says, boss, the restructured Greek sovereign debt under English law is trading at a discount to the existing or remaining stock of Greek debt under Greek law. And Ted, you don't need to be a sovereign debt lawyer to understand that. You'd think that a restructuring in English law is somewhat of a legal upgrade. I don't wish to offend anyone listening, but I think that's probably true. But it was a most unusual situation. This young lady said, I've done some reading. I can find no history or no previous example of restructured sovereign debt under English law trading at a discount to the remaining stock under local law. I think there's a lot of force sellers who are missing the point. And the boss said, I'm going to put you on a plane from Kennedy to Athens tonight. Off you go. And she went to Athens and she spoke to people because not to mention her view, but to try to understand what she might be missing. And of course, she wasn't the only one. There were about a handful of people who were onto this. But again, a brilliant example of how you encourage people to speak up and think. Off she went. She triangulated what she thought she knew, she reported back to the boss and they bought an awful lot of restructured Greek paper under English law in the teens, which turned out to be the most fantastic investment. And what happened after that was a bonus. It was the original analysis. You know, Sam Zell likes to say, liquidity equals value. It was like, if I'm buying the restructured Greek paper under English law in the teens and it goes to zero, that's going to be quite humbling. But you know what? I'm going to allocate X to it, knowing that if X goes to zero, we're still a going concern as a fund manager and years later they're selling those things in the 70s and 80s and taking profit and moving on. But the lesson there is, for all the smash up in the Eurozone, all the policy mistakes, the people that ended up doing the best were the people who didn't try to be sovereign debt heroes. They didn't try to short all the banks, although Deutsche bank is the gift that keeps on giving. They didn't try to be geniuses. They said, right, we know what's happening. It's beyond our circle of competence. We understand what the spillovers are, but we're not going to change our mandate just to participate. We're going to wait and then along comes the opportunity. What a lesson. What a lesson in investing. What a lesson in process.
- [26:40]
What is it that makes a great manager, money manager, and what you've seen, and particularly in the macro space where there's a trading aspect to it as well as sort of often a fundamental thesis.
- [26:55]
First and foremost, Ted, what makes a great fund manager is that they are long time. They are long time, they are never short time, they never give their time away. That's the first point. The second point, when we think about macro, maybe we should think a bit about what macro was and then what macro became. You think about macro in the late 60s and early 70s, back in the day, and you think about what quantum was. And if you read some of those early quantum shareholder reports and you compare them to the present day, it was like, this is what we thought, this is what we did, this is how we did. Thanks very much. Whereas in the modern day no fund manager update would be complete without some reference to the Dalai Lama or I went to China and I saw an empty building and then I was there just talking to my yogi and it's like, who cares? But the serious point was part of the tremendous success of the true macro pioneers was the broadness of their mandate. I will have a top down view of the world, but I will use any instrument under the sun to express it. Compared to the more recent past where macro has become institutionalized, in fact, too many macro businesses have become volume targeting. They take money from some asset allocator who says, don't lose more than X and you can only trade equity indices, short term interest rates and fx. Is it any wonder that people have struggled? The point being that we went from a very broad macro environment where things moved to a very constrained macro environment which made it difficult for people to express what they wanted to express. So what makes a good macro manager today? And you know, of course, I'm replying from a subjective point of view because I know a few of these guys. Firstly, it has to be a broad mandate to be able to use single stocks, for example, to optimize A macro view to be able to trade exchange traded Korean derivatives if the mood gets you. I mean it's an enormous liquid listed derivative market in South Korea of all places to express a view on Japan by a particular sector or basket as opposed to. I'm just long topics basically to differentiate yourself from everyone else by being taking advantage of things that may not be quite as crowded. The ability to avoid all the macro roach motels is the critical thing. Secondly, in fact it might be the most important point. You need the right clients. You need the right clients. You can't have clients who ring you up every Friday saying what have you done this week? That is just no way to manage money. But I'm afraid that's tended to go hand in hand with a lot of the institutional allocations that macro managers and hedge fund managers more broadly have changed. They sit on your shoulder all the time, meaning that you feel you can't lose any money at all. And if you can't lose any money at all, then you don't feel terribly compelled to take any risk. It's a pretty nasty circuit.
- [30:13]
Let's talk about today's markets. Maybe the place to start is the epicenter, the Fed in the US what's going on in the plumbing? What are you talking about with your clients? Of things of concern and areas of opportunity?
- [30:28]
Just come to the Fed in a moment. But you've just reminded me of an important point. Point. It's dangerous when you're considered to be an expert on something and I think it's still fair to say that people know me as the plumbing guy. But it's dangerous if you come to be known as an expert because it means you might shut your mind off to new ideas, new information. And the plumbing of the financial system is an extraordinary, complex, dynamic system. It's not a static system. It's dynamic, of course it is. And yet there's so many people out there there today. Ted, putting out charts with two lines from relationships. These infamous cross currency basis swaps, or apparently the ebbs and flow of the treasury general account, the deposits the US treasury has at the Fed explains everything that's happening in the world today, which I think is just nonsense. And they say, oh look, here's two lines that vaguely resemble each other. One proves the other look out, we're going to help. It's like, well, no. And the key point I'd make that far from explaining to people over the past two years what's going wrong in the plumbing, this notion of dollar shortages and stuff like that, which is a little bit off beam. My job is to explain to people what's actually going right. What's actually going right. Opportunities arising from being able to lend dollars if you're a reserve manager in a sensible risk control way and earn a few more basis points, very controlled way, or to lend out your treasuries, or how Japanese institutions are lending their dollars in a much greater scale, which is lubricating global money markets and increasing the float of dollars. It's a change, right? So it's not what's going wrong, but it's explaining to people how relationships have changed. There's an obvious feedback loop between post crisis regulation and what central banks have been trying to do. In fact, you might argue they're at cross purposes. But it's to try to help people explain how the is adapting and evolving. And I'm very fortunate to count key men and women in the plumbing as dear friends. So if I don't understand something, I can pick up the phone to my friend who's the treasurer at XYZ and say, am I thinking about this the right way? Or the CP guy or the swaps guy, or the STIR guy and say, hey, look, if I got this broadly correct, and I find that immensely helpful. And really, Ted, if people think of me as a plumbing expert, it's not because I know anything about the plumbing. Really Seriously, it's not. It's because in my experience, the plumbing of the financial system is so complicated and constantly subject to change in ebbs and flows that nobody can know it in its entirety. So if I do know anything about how this works, it's only because I never stop asking questions. That's the key. And we live in this day and age where everyone seems to be entitled to their own facts and accusation is taken as evidence. And it applies as much as in political discussions as it does to observations about how the financial system works or how the Fed works, or how the U.S. economy is evolving. Oh, here's two charts. And we've all seen this. Here's two lines. One advance six months, we're going to hell. Great. That's fantastic. That's so helpful. I'm sure. You and I, if we challenged each other over the next five minutes, we could go into the Bloomberg and prove that mobile subscriptions in India drive dollar funding markets in Hong Kong. But if we lag it long enough, right, I'm sure there's a link, but you know, that's the danger. So my challenge, in fact, when I reflect on most of the advice I'VE been trying to impart to my clients over the past couple of years. It's been more of the perspective of that's not right. Well, that's not quite right. Here's why here's a background paper, or here's what this money market fund manager has actually said, or here's what this US Corporate treasurer has said, or here's how banks are actually responding to U.S. tax changes, et cetera. So it's to give people a broader perspective. And I think there's a phrase one of my clients like to use which I think applies to investing in general, which is the mindset of constructive paranoia. Constructive paranoia. And you mention that to people, Ted, and they say, oh, you're one of them. You're one of those left tail people. It's like, actually, no constructive paranoia. When you're thinking about markets and asset allocation. Investing is as much about oh my gosh, am I overexposed to something that might go wrong? As it is about, oh my gosh, am I underexposed to this particular opportunity that people haven't re rated yet? So it works both ways.
- [35:24]
The paranoia, the left tail starts with US Rates.
- [35:28]
Sure does.
- [35:29]
And there's a simple case that we went from private debt to public debt in the US since the financial crisis, rates have been incredibly low.
- [35:39]
A very large asset swap, effectively. Right. Yeah.
- [35:42]
Should rates normalize? Can we afford this? And what happens? Take me through your thoughts.
- [35:49]
When I think about central bank reaction functions, first and foremost I say to myself, what would I do if I was one of them? That's got to be the starting point. And we know so well, Ted, that there's been this great tendency over the years by market observers and commentators to project their opinions onto central banks. They will, they must, they should, they shouldn't. This is crazy. Doesn't matter. It just doesn't matter. And if you imagine what it's like to be sitting around that table when the Federal Open Markets Committee meets in Washington with their mandate and their institutional imperatives, and not only that, but at everything they've had to do over the past several years, you too would be slow and gradual. And if inflation does perk up, that is a high class problem. To have given everything you've had to do. It has been the only game in town, particularly in Europe, and probably will be in most jurisdictions for a long time to come. So we can huff and puff about balance sheets or we can say, what are these people most likely to do in their seat? What are their incentives? That's the key Point. Now the Fed gets criticized for their communication and I have to say over the past 18 months they have been so transparent and so clear about what they're trying to do. And yet up until recently, markets were fighting it. I mean, you had this extraordinary event in March 2017 where Janet Yellen thinks that her Federal Open Markets Committee have made it abundantly clear they're going to hike in March. And yet the Fed funds market was not willing to price it in. And they all went, the key board members into the financial media to say, no, no, we're actually going to do it. It was like an out of meeting rate hike hike. Because Marco's like, no, it's the Fed, the nincompoops. They don't know what they're doing. Oh, it's the Fed. They're always wrong. Which is, I think is a little bit unfair. I mean they're not stupid people. They just move to the beat of a different drum to the rest of us. And they managed four hikes in 2017. But let's go back a little bit to September last year and how people were able to do very well simply by paying attention to the Fed. You had the grand total of 0.2, that is no rate hikes priced in to the US short term rates market in all of 2018 and all of 2019. Now you don't need to be a genius to think to yourself that's probably a bit pessimistic. So people who understand how the Fed's thinking and looking at the economy with a broad perspective and, and guesstimating the probability of Republican tax cuts said that's just silly prices. So they start tapping out a few Euro dollars, putting on various curve trades, getting stuck into mid curve futures, stuff like that. And then you get to the end of the year and contrary to expectations, the Republicans have delivered a tax cut. And then I know this is a tiny bit in the weeds, but it's very important, I think, to understanding where the Fed's going. And then you get to January 11th this year. Now, by the way, just as we entered the start of the year, something different started happening in financial markets right now we've been used to years of asset prices levitating and implied volatility across all asset classes coming down. But as we came through the first couple of weeks of January, asset prices are still going up and guess what? Implied volatility stopped going down. Now that's interesting. So you just write that down the notebook and go, okay, something's changing here. Don't Know what? But equity index implied volatility is no longer reacting the same way as it did previously. January 11th, Bill Dudley, who's the outgoing head of the New York Fed, very important man for a long time the world's favorite dove. But as the data evolves and the economy evolves, so too does Bill Dudley evolve as you and I would if we were him. We're responding to new information. He gives a speech, he talks about this, this rather nebulous concept of star neutral equilibrium, real interest rate, a whole bunch of gobbledug, but it's going up. And that he thought three to four hikes in 2018 would be slow and gradual. And basically the economy is looking pretty robust to say the least. Nothing happens. I remember picking up the phone to one of my short term interest rate friends and saying, am I following the wrong economy if I misread this speech? And he's like, we're sitting here thinking the same thing. This is like a really. Compared to the baseline, this is a really hawkish speech from Bill Dudley. And basically the front end of the US term structure has moved about a basis point. He said, look, I think this is wrong. I've sold some more Euro dolts and stuff like that. And then a week later, this is how the games works, right? A week later, Bill Dudley, I'm paraphrasing, but rings up the FT and says, I need to speak to you. Grants an interview to Sam Fleming, who does a wonderful job covering the Fed at the FT in Washington and goes to Sam and basically says, bang, bang, bang. No, I mean it. And then you start to get a little bit of more pricing in US short term rates. And then a week after that we get the high inflation prints and then two weeks after. That's unlike Donkey Kong. Now the serious point is, if you look at financial history, it tells you that when realized inflation goes up, not implied realized actual inflation goes up, guess what? The correlation between stocks and bonds changes. Who knew? And the correlation between stocks and bonds and credit changes, as it should. And yet the world has become accustomed to the idea that the correlation between stocks and bonds is predictable and exactly the sort of, of amplitude and magnitude where it is today. And it continues to change. So the point is, if you've been paying even a moderate amount of attention to the fed from the third, fourth, even all of 2017 onwards, and especially the start of this year, there's been an awful lot of money to be made. And then the challenge was to calibrate what the spillovers might be where the Fed's at today is still slow and gradually working out how to retreat from forward guidance. And what Jay Powell is trying to do is to reactivate the market mechanism. Now, notice I didn't say price discovery. Price discovery to a central banker sounds a bit scary because it might go further than you think. But to be fair, Jay Powell is trying to find a way to reactivate markets while avoiding a rerun of the taper tantrum. It's tricky. But far from being concerned about a further tightening of financial conditions or further increases in realized and implied volatility to them, it would be perfectly logical and expected. And Ted, the whole point of tightening monetary policy is to tighten financial conditions and eventually bring asset prices down. That's the point. And yet the market continues to impose and project its view on the Fed. No, they're wrong. The yield curve's inverting. Believe me, if the Fed wanted to steepen the yield curve, they could. Oh, they could. They have the power to do it. Might be quite a dramatic thing, but they can do it. But this narrative that things are going wrong and yet the Fed is like slow, gradual, slow, gradual. And what the FOMC is trying to articulate to markets who are not willing to listen is that they think that they're going to keep hiking rates for a long time to come. And yet. No, no, no, they're Fed. They're idiots. Here we go. Global PMIs are rolling over. Well, I need to give it more study. But when I look at global PMIs, the reason they're declining a bit is because of capacity constraints. And capacity constraints and bottlenecks don't strike me as late economic cycle. They strike me as mid economic cycle issues. So there's this disconnect. So my challenge is to pay attention to the Fed. They are an important central bank. They put tremendous effort into all their communications. Unsurprising, tremendous effort. And they are going to be slow and gradual for a long time to come, barring a tremendous exogenous shock. And the final point I'd make is, look, let's step back a bit. This has been the first occasion since 1964 when a US economy perilously close to full employment has embarked on tax cuts. You would think based on that observation, the probability is higher that in 2018 and 2019 the US economy will run a bit hotter than it has done over the past several years. And while I think of it out of necessity, all these morning calls around the world over the past several years, you know, these global calls have started with ambitious young women and men speaking to their colleagues on a speakerphone. It starts with which central banker said what? Who's up next? What did it mean? And then, and only then do you get into discussion of what was Singapore, non oil exports or what's happening in Korea, or best of all, what are we learning from our portfolio companies? And these global corporations are as sophisticated in their inventory management, logistics and order books as any hedge fund sitting in front of Bloomberg. The investment they've made in logistics, infrastructure, whether it be SAP, HANA software. These guys have their finger on the pulse of the global economy. And I'm struck by the disconnect between the consensus macro commentary on how the U.S. economy is perilous or global growth is perilous, or emerging markets are in dire strait. I find that difficult to reconcile with the commentary that continues to come from global corporations about order books, forward order books and everything else. My sense is subject to revision, that we're looking at late cycle asset price valuations. But shockingly, the US economy might be mid cycle and that might be the opportunity for people who are prepared to take a step back and look at things. And look to be fair, I wonder whether too many people are caught up by the first White House tweet every day and that drives oh, what he said now. Oh, the man's done. Oh, you know, they go on and on and on and therefore by looking at the world through the prism of the President, people are biased to look for what's going wrong as opposed to what could be going right. I think there's an opportunity to step back from the consensus narrative and focus less on what central bankers are saying because they're reacting to the exact same data that we can see. And they're reacting to input from US and global corporations. And in this age of crowded positions, leveraged exposures, if I'm going to wait for a central banker to give me permission to reprice something, it's too late. If I'm gonna wait for JPAL to say it's now okay to sell the long bond, it's too late.
- [47:54]
Ted Seides
We're going to take a break in the action to tell you more about Morningstar Data isn't just a byproduct of your business, it's the driving force. But where's it taking you? Morningstar Data clears the way forward, a decisive language of insights for investment professionals to implement conviction led strategies across both public and private markets. Visit wheredataspeaks.com to see what Morningstar Data can do for you. And now back to the show.
- [48:26]
James Aitken
So James, some of the assumptions, these core faulty assumptions you talked about. You mentioned US rates will stay low forever. You mentioned in a real inflationary environment, the correlation of stocks and bonds changes. Are there other core assumptions that you think markets are making today that are faulty?
- [48:48]
I'm sure there's a great number of them. But of course, for me to assert that a market is faulty or the assumptions are faulty, you need to be careful that one is not too arrogant because Mr. Market is not always wrong. Markets, I think of them as a contest of ideas. One guy working from a broom cupboard in Wimbledon and needs to be careful how he.
- [49:13]
Ted Seides
Let me rephrase the question.
- [49:15]
James Aitken
Are there any things that you see that you suspect are common knowledge that you have a different opinion about?
- [49:24]
I am struck by the number of people who claim to be China experts because I don't know what that means. I encounter a lot of people who are very good at a particular part of understanding China. So there'll be the person who's very good on shadow banking and wealth management products and Chinese plumbing, which unfortunately tends to mean that they look at China entirely through the prism of their knowledge. And unsurprisingly, for the past 18 months, oh, it's all going to hell, you know, deleveraging. And then there'll be the person who's looking at the Chinese technology giants and, and everything's going to the moon. And then there'll be the property person and everything's going to hell. And you go round and round. Look, let's face it, unless I'm on the Politburo Standing Committee, I'm not going to know too much as designed. I'm just not. And this narrative that China must, would, should they have to, this, that and the other, I think we need to be very careful with that. So the common assumption that worries me most about China is that they must have a subprime like crisis at some point. I'm not sure about that. A financial crisis, some kind of credit cycle, liquidity cycle, defaults for sure. But to use that subprime mental model and apply it to something as complicated as China or anything else I think is a bit, bit dangerous. When it comes to, for example, shadow banking and spillovers in China, what do we not know? We've had more and more information released. We know the stock, we know the flow, we know the players, we know the cross links. We can sign up with a WeChat account and talk to bankers onshore in the mainland. But it's just one part of the puzzle. And you have A man running the show for as long as he cares, to President Xi, who takes a long term view and he's trying to figure out how to rebalance the Chinese economy. It's a toughie. No one's tried to do what he's trying to do. And if we were him, we'd probably take a lot of time to figure it out. Which is why I say deleveraging with Chinese characteristics. What Chinese financial policymakers would like us to focus upon would be that the rate of growth in credit and shadow banking in the Chinese economy has declined abruptly. But the key thing there is that's the flow rate of growth. The stock is still rising. And perhaps I'm being simplistic, but I don't see how you ever deflate what is frankly a gigantic liquidity bubble rolling from asset class to asset class inside China without some pretty stern consequences for Chinese gdp. And that's the downside of being in charge of everything. If you're President Xi, if everything goes right, ta da, I did it. But on the other hand, if you're all powerful and in charge and anything goes wrong, it must be your fault. I don't think the Chinese economy can afford too much deleveraging. Now, it doesn't mean there won't be mistakes from time to time. But you look at the new leadership of the People's bank of China. They're very sophisticated when it comes to the plumbing. And while the People's bank of China's balance sheet has been coming down, which I think has been under reported from my trip to China last year, number one takeaway is I will never understand this. I just can't. I just can't get my head around the enormity of it. I just want to be less wrong. So we're told for years that all these Chinese property companies and Chinese corporations are borrowed in dollars. If the dollar goes up and the Fed tightens policy, they're in a world of pain. And this young man managing a Chinese bank balance sheet in Beijing casually mentions Ted, that, oh, we've got our $300 billion offshore balance sheet. I'm like, stop. What? Oh, yeah, we've got $300 billion in our offshore balance sheet. Oh, what do you own? Oh, well, there's a few Treasuries and guess what? Dollar paper issued by Chinese corporations. I'm like, wait a minute, you mean all these dollar bonds are stuffed into the Chinese banks in their offshore balance sheets? Yeah. And then I triangulate it. I call a couple of large fixed income clients in The Far East. And I say, look, you've expressed an interest from time to time in owning dollar bonds issued by Asian and Chinese corporates. How many have you been able to buy? None. Why not? It all goes into the Chinese banks. You got to think differently. Suffice to say, the Chinese like to support the home team. That's never going to change. Then there's another angle to this that I think is important, Ted. Rather than getting caught up in the game of predicting Chinese policy or economics or tariffs or trade, or predicting what the PBOC is going to do with interest rates or the renminbi or whatever, is there anything happening that is a structural change that is not about predicting, but is structural? And the answer is, of course, yes. And we're just at the start of Chinese onshore financial markets being plugged into global capital markets. And over a long period of time, I think that's going to change correlations everywhere. I really do.
- [55:11]
In what way?
- [55:12]
Well, global asset allocators, out of necessity, will have an increasing amount allocated to onshore renminbi assets. Now, of course, it is easier and it's taken a while to plug Chinese equities into the MSCI indices. Plugging in onshore credit and fixed income, which is a gigantic market, into global bond indices is much trickier. You got to think about custody, you got to think about, can I hedge onshore? You got to think about repo. And of course, plugging in onshore Chinese credit and fixed income requires further opening of the capital account, because you and I are not going to commit X billion to Chinese government bonds if we can't get it out. It's just not going to happen. So the fixed income and credit bit is going to take time, but it's coming. Meanwhile, the MSCI inclusion has started. And over the past several years, the ebbs and flows of Chinese onshore equities have seen more about the rotation of the Chinese liquidity bubble. So this gigantic liquidity bubble inside China rotates from housing to bonds to commodities to stocks, and round and round it goes, whatever's hot next month, until the authorities say don't do that anymore. So for a long time, Chinese equities have nothing to do with fundamentals and everything to do with liquidity and speculation. But what's interesting over the past, say, three to six months is to observe and to work with clients who are picking Chinese stocks onshore and to notice how Chinese equities seem to be slowly more aligned to what we in the west might call fundamentals. So responding more to Earnings results better calibrated with multiples. Now this is an iteration. There's a wonderful friend of mine told me the other day that, that some of the best performing external fund managers he's had since the early 2000s have been onshore Chinese long short equity hedge funds. There's a structural shift occurring. We can be as skeptical as we like about Chinese policy and economics. In fact, we should be. We should be. But is there something that's structural that's changing? I don't recall any country being included in the MSCI indices to be subsequently excluded. But I'm afraid the facts are that whether it be passive money or active money, over the next several years there will be increasing allocations to Chinese onshore equities and that's not going to go away. I know that this is going to be a powerful change for global capital markets. So I need to find a way to calibrate it. I need to find a way to think about this structural shift and how there's probably a great opportunity for stock pickers in the mainland if I can find some. And I need to calibrate that structural change against the deleveraging, the complexity of deleveraging, the way China's trying to come to grips with this extraordinary stock of debt and shadow banking and trying to calibrate the trade offs and most of all trying to be proportionate about an immensely complex gigantic economy about which by design Westerners will never know much.
- [58:40]
So let's turn to something that's been more stagnant and always seems on the cusp of change, which is Japan. It seems every few years there's an anecdote, there are people still in the graveyard from shorting JGBs, there's structural reform in the corporate sector. What are you seeing in Japan?
- [58:56]
I'm seeing a lot of opportunity because it's boring. I love boring. Boring compared to everyone being an expert on why Abe's three arrows were going to drive Dolly into infinity and all that kind of stuff, right? And all these people projecting that, oh, this is the greatest macro opportunity of all time. It's quite striking how few of them actually made any money out of that. But look, Japan's still ticking away a little bit of a setback in the economy in the first quarter, but by and large it's looking pretty good. The bank of Japan sort of waffles from time to time about exiting their asset purchases. I don't see how they can, I really don't. And I could get myself into a lather about what it eventually means for the JGB market and everything else. Or I can step back and say, are there Japanese corporations that are absolutely the best in the world at what they do? And the answer is of course yes. And it's not just about robotics, it's about a whole, whole range of things. There's even activists getting involved in Japanese equities, by the way, under Abe's patronage. He's like, look, if I can't convince my countrymen to do it, can you come in and give it a kick? And you know, it's been a good opportunity so far for people with a mandate to do that, you know, whether they be here in New York or elsewhere. And it makes sense, but there's still these companies out there who I think it's quite cliched these days to say own Japanese banks, but I've liked them for a long time and I like to stick with them because I know how much they've invested in their risk management technology, I know how much they've upgraded their personnel, I know how keen they are to understand how they run their balance sheets and stuff like that. So I think they're in pretty good shape. And there's further re rating. So I think of Japan as I need to keep an open mind. I need to keep an open mind. I think there's less excitement surrounding Japanese equities broadly. And my suspicion is that I need to retain a core minimum allocation to Japanese equities more broadly. And if in doubt, I'll just stick it in index fund. And actually that's what we have. I just want to sit it over there and just ride it out.
- [61:00]
Let's go from boring to exciting. Get back home for you so you don't have to talk about being a guy from Wimbledon thinking about China. How about Europe?
- [61:10]
Oh, it's all good, Ted, it's all good. Look, what is it about these people that they always want to play chicken with their own financial system? What is it? There's been this obsession with the Draghi wizard as I think of him, for the past several years, which is fair. He's an extraordinarily accomplished, fiendishly market savvy man. But look, people have sweated and obsessed over everything he said, which is important, about short term interest rates, about quantitative easing, about lending, about everything he's done, which is important if I'm trying to duck and weave through FX trading, trading, Uribor trading, various curves in the Eurozone. But I took a step back from all of that the other day and I just read through the transcripts of the opening statement he has made at every Governing Council meeting since, whatever it takes. And when you step back from all the what's he saying now? You realize that he opens every Governing Council press conference with a plea for structural reform and nothing's happened. He basically says, well, he's saying two things. A, if it goes wrong, it can't be our fault because the ECB has done things that it was never designed to do, which is true. And then he also says that, look, you really need to follow up, please, Mr. Politician, follow up on structural reforms. But you keep promising but never delivering. There's no banking union, there's no capital markets union. And arguably, given the setbacks, the self inflicted setbacks that Merkel has had, the probability that we're going to get widespread structural reform is going down by the minute. And then we have this extraordinary episode over the past few days and I'm afraid I was not nearly as astute as some of my clients were in March when you had this election. And a couple of them said, hey, this, this doesn't smell good. And I was like, okay, I was more focused on US rates, which was a mistake. And then you get this Mattarella not denying that Italy can't have a referendum at some point on the euro, but basically denying these two guys who wanted to form a government come charging in and saying, right, this is what we're going to do before they put it to the Italian electorate. So guess what? We had some pretty spectacular price discovery. I'll say straight up, I'm not sure what this all means yet, but at a minimum, it's refocused people on unfinished business and economic and monetary union and perhaps permanently unfinished business. And how the heck can the ecb, which is the only game in town, ever step away from asset purchases? How can they? And we sometimes forget that we're talking about global growth being X or realized inflation being Y. And the Fed's balance sheet is still 4 trillion plus. The ECB is still buying assets and the ECB is still policy rate is minus 40 basis points. What on earth might be the market clearing price of risk with regards to Eurozone peripheral credit were it not for minus 40 basis points and a certain amount of ECB asset purchases. So when I look at what's happened the past couple of days, people are already stepping in to buy the Diplomat. And I'm not sure that's right. I'm really not sure that's right. Now, as a tactical opportunity, go for it if I can scoop up a few BTPS at 300 over bundes. Great. But at 300 over bundes, effectively that is implying, I mean, this is subjective, but effectively implying a 30% probability of some kind of redenomination or tactical default in Italy. 30%, my word, that's not good. So the tactical trade, go for it. But the structural problem, not going away. But there's a bigger lesson. Ted, if I may. Central banks, with the exception of the bank of Japan, have been signaling for a year or more that they are trying to reactivate financial markets and financial markets don't want to hear it. There's a very fine fellow called Jeremy Stein who was at the Board of governors until 2014, and in his last speech before departing the Board, he reflected upon the taper tantrum in 2013. And I've reflected a lot about that too. It's popularly believed that the taper tantrum was a colossal communication error by Ben Bernanke. I'm not so sure about that. He was telling people via his speeches from February 2013 onwards that he thought us long term interest rates were too low and people just refused to listen. And in reflecting upon that period, Jeremy Stein delivered this tremendous speech and he talked of leveraged quantitative easing optimists, in other words, people who were fully invested in the idea that central banks would have their back forever. And I think that pretty much describes where we are right now, the last 10 years.
- [66:40]
That's been the winning strategy. That assumption.
- [66:44]
You're dead right.
- [66:44]
Has been the winning strategy.
- [66:46]
You are dead right. But from time to time we get attempted regime shifts by central bankers attempted. And that's when we need to be on guard. And when central bankers privately and publicly tell you over and over again that we're trying to reactivate markets and when they go on and on about oh geez, implied volatility is too low, they're actually saying that our tolerance for some kind of market correction is higher. Which makes sense when in some parts of the world, and particularly here, you're trying to tighten policy as you look.
- [67:18]
Around the world to asset market markets as opposed to rate markets or currency markets. Where do you see risk?
- [67:25]
I think the number one risk is the assumption that long term interest rates can only go down. That's the number one risk that underpins, I think, nearly every major asset allocation around the world. The assumption that we are perpetually mired in some sort of secular stagnation. But Ted, secular stagnation is a euphemism for policy failure, meaning that secular stagnation is a choice. And we're just starting to see in this country now the long term consequences of going for it with tax cuts, not to mention the extra 300 billion spending that they shoved into the budget in January at this stage of the cycle. Or there'll be some consequences. But one of those consequences might be sharply higher long term interest rates in this country. Which means that the discount rate that people need to apply to evaluate various assets for the first time in many years goes up potentially a long way. And I don't think markets are ready for that. And I think the market's ability, as we've seen recently in btps, to intermediate an abrupt change in thinking is impaired compared to previous cycles.
- [68:35]
So where the institutions have been piling their money are in these long duration assets. So more and more in private equity you hear about private credit. And on the one hand, from an investment perspective it's nice because they get out of their own way. For sure they own an asset for a long period of time. On the other hand, the longer the duration, the more the risk that they're going to get hit if these rate, if rates do eventually move up.
- [68:54]
Of course you're correct. Let's think about incentives. And this is where central bankers get muddled. And many of them say to me, James, we're trying to tell people that we'll tolerate more volatility and we're not interested in holding the market's hand anymore. And it's time for people to think for themselves. I'm like, yeah, that's great. I get that people appreciate that. They just don't believe you. But then from an asset allocation perspective, think of it this way. If central bankers keep saying over and over and over again that when they're done hiking this cycle, they'll end up at a number much less than previous cycles, which seems reasonable, frankly. So fed funds doesn't get to 525 basis points like it did in 06. It gets to something like let's say 300, which I think would surprise some people if we got there. But that's where I think it's the minimum. And if you, Mr. And Mrs. Central Banker say that when we're done, terminal policy rates this cycle will be much lower. You're advertising to every long term asset allocator, nearly all of whom are chafing under heroic, if not absurd, return targets, mid to high single digits, you are telling them that if terminal nominal policy rates are going to peak out at a much lower number, then the nominal return on risk assets is going to be lower. And the only way I am going to meet these absurd return targets is by remaining fully invested and owning duration, which is great right up until the point you made. Because if I'm assuming a steady state discount rate, great, yeah, no problem. But then I sort of add 100 basis points to it.
- [70:38]
Oh, if you were in front of the chief investment officer of a pension fund or an endowment, different liability structures, how do you take and synthesize the information that you have and advise someone on how to shift or think about their portfolio differently for this period of time coming up?
- [71:01]
I start by trying to understand if there's been any changes in their process or any changes in key personnel or are they under pressure, you know, trying to understand their incentives. I've had this conversation with one very large pool of money, and he was actually saying, this is a great example. Actually, it was during the Eurozone crisis, and we got into a great discussion about what was going wrong. And he said, james, you know, I get all of that, but I'm sitting on top of $100 billion and given my mandate, I just have to bull through it. And I thought that was a great lesson. He said, I've just got to stay in the game. I can't duck and weave, I can't flip, I can't hedge. I just got to suck it up. And that's important. It's often overlooked, frankly. I don't want my pension fund clients and endowment clients and family office clients to be in and out of stuff and trading. That's really counterproductive. But my number one challenge is to explain some of the things we've discussed about the Fed in a simple, understandable way. To be able to condense it into this is what's material to you. And some of the things we talked about. One of the topics that comes up a lot is how should I think about my exposure to onshore Chinese assets. The other thing is a lesson on liquidity and what markets are like. Today is in nearly every discussion. If you're waiting, as we said earlier, for Mr. And Mrs. Central Banker to tell you it's okay to rebalance, it's too late. You've got to have a strategy. You've got to have a plan. So it's a whole range of things. But also, Ted, the most interesting part of the discussion with a pension fund or endowment or family office is what are people not talking about? And that's where you learn so much, hey, what are people not talking about that you think's really interesting?
- [72:54]
And what's the answer to that question today.
- [72:56]
India. India. And here's what I'm wondering about. It's a big place, it's a complicated place, It's a. A bureaucratic place. It's not going away. And in the not too distant future, it'll have more people in China. And some of the conversations that are starting to come up I find fascinating because it forces me to broaden my knowledge and get outside of my comfort zone. So here's this country that is probably a structural opportunity. So take one example. We're all experts on Chinese technology giants. My gosh, these things are juggernauts. I mean, just juggernauts. And we all know the valuations. Let's say simplistically, that the market cap of the Chinese technology giants is a trillion dollars, subject to what the next tweet from the White House says. What's the total market cap of Indian technology companies? Now? It's not a big number. Now, if we include Tata or not, Infosys and so forth, let's say for simplicity, it's $20 billion. What? And again, we could debate whether we include Flipkart or not, but in private placement, put it this way, it's a very low number. And yet you have these immensely talented Indian men and women doing extraordinary things in technology all around the world, not to mention running important companies in the Bay Area. I'm like, yeah, that doesn't make sense. Now, it's not as if the Indians are about to allow foreigners to throw money into the Indian equities. And it's not as if Indian authorities are about to let foreigners jump into Indian credit and fixed income effects. It's often awkward to do so. It's like, wait a second, I'm not thinking about India properly. I'm not. But that's one dimension. Here's another. China, China, China, China, China, China, China, China, China. Every conversation, China, China, China. One belt, one road, one belt, one road, one belt. Yeah, it's important. And the reason we hear about it all the time is because China is the master of propaganda. Yes, of course they are. So we're inundated with commentary about one belt, one road, one belt, one road. But look, it's big, it's real, and it's China getting people to buy into the China dream. We know that. Why is nobody talking about the Delhi Mumbai industrial corridor? I'm ashamed to admit it was not until I had lunch with a great friend who lives on the same street in Wimbledon, who's this great emerging market equity investor. He's so enthusiastic. He put up a slide. Dmic. I'm like, what? He's like, yeah, Delhi, Mumbai industrial corridor. I was there last week. Here are all the companies developing it. Unsurprisingly, Ted, Delhi to Mumbai captures an awful lot of humanity. And here's what they're doing with the roads, here's what they're doing with the railways, here's what they're doing with the infrastructure. India's getting it right and it's not getting much coverage. I'm like. And he's like, it's investable and I'm loving it because it's investable today. No one's talking about it. I allocate my capital patiently and if I've done my homework correctly and Modi's backing it and the whole government apparatus in India is backing it, I feel comfortable with that. And then I'll come back in a few years and so forth, forth. And I started reading about this and it comes back to the China narrative. Oh, look how many people we've lifted out of poverty. We have lifted hundreds of millions of Chinese out of poverty. Yes, you have. How many million people is Modi going to lift out of poverty? Right. I reckon it might be more than the Chinese have, but. Just whisper it. But then there's another dimension to this. Now, because it's India and because it's happily a democracy, it's going to take longer to do things than the Chinese where it's just like, hey, do that, or you know, you're on the next bus to Mongolia. So there's going to be frustrations, there's going to be bureaucracy, but it's happening. But here is the next observation. What if India today is at the same point of its commodity demand cycle as China was in 2003? Now that could be big. And my suspicion is that that hunch could explain part of why global commodity markets and energy markets remain fairly well supported. And I need to do more homework on that. But you recall in years gone by with, we used to reflect on what the filling of the Strategic Petroleum Reserve in Louisiana salt caverns meant for the energy markets when they were topping that up. Then we were experts on China topping up their Strategic Petroleum Reserve. And you look at India's Strategic Petroleum Reserve, they got a long way to go. So I'm trying to learn as much as I can about India because like China, it's not going away. It seems to be under covered from my perspective, it seems to be under discussed. And yet structurally, I feel like I need to know much more about it. And I'm encouraging my clients to think about it. It's not to trade it, it's not to sort of punt it. It's to think about where India is in its cycle and what could go right in a day and age where every conversation is dominated by China.
- [78:29]
I want to ask you about your time. You mentioned that Warren Buffett has an empty calendar. You sent me a book list of books that you clearly have read that were. Let's just say it's a long list. And in this day and age, there's so much happening on social media, which is the opposite of a book. So how do you spend your time and how do you think about what's important and what distracts you?
- [78:56]
We are in a world that preferences the reactive over the reflective. And I would have thought, if one is hoping to succeed as an investor, an allocator of capital over a long period of time, you must preference the reflective over the reactive. So you invert what too many people are doing today. And as Shane and other people and Mr. Buffett and others advise, the most precious asset all of us own is not some stock or bond or private equity investment or whatever. It's our time. And since I've been working for myself, one of the things I've had to learn is to say no. That's the most important thing. And my dream week is to open the calendar, and other than family commitments, there's nothing in it. That's my dream week. I'm not always able to do that. There's always someone interesting to speak with or talk to. But I find that all the mistakes I make are either because I pretend or I get caught up in a narrative that I don't understand and I haven't adequately reflected upon. Or, heaven forbid, I get caught up in the group think or I go down some ridiculous rabbit hole on Twitter, which is apparently insight, although I do have my doubts. So it's a battle. But it starts with discipline, and I continue to work on that. And when I started working for myself, I really ramped up my reading. Why? Because I couldn't. If you're sitting on an investment bank sales desk, you can't sit there with a book in your hand. You'll be out in the street. I really ramped up my reading, and it's humbling. Every day I walk into my library and I look at the shelf of unread books. My wife often asks why I've not been invited to join the board of Amazon. Goodness knows, I'll Give him a bit of support. But I look at all these books and I think, my gosh, how could I have not read that? How could I have not known that? How could I, oh my God, I've not heard of her or him or that or that event. This is terrible. Right. I'll say delicately, you know, mid lifeish and I benefited from a wonderful education in Sydney thanks to, thanks to mum and dad. I went to the University of Sydney. But I gotta say, I feel that my education truly began when I started working for myself and I started carving out huge chunks of time just to re and think and reflect and it's a journey. And look, I'm not saying that I've got it sorted out. I'm not saying that I've figured it out. Far from that. All I know is that the more disciplined I am with my time, the better I seem to understand issues of the day. And I say to my clients that related to your question, I'm just trying to be less wrong. I'm trying to be less wrong. And if I can come to grips with that and I'm patient and I read then from time to time I'm hopeful there will be opportunities that I can steer my clients toward. Whether they be being sensible after Brexit, whether they mean the investing opportunities in January 2016 when you had certain Asian equities trading at Asian crisis lows. I mean, that's just absurd. Well run businesses with good balance sheets. The opportunity in US short term interest rates, sometimes you have to wait a while. But the more you step back and create the space to reflect, my hunch would be you're more likely to be less wrong. And that's the challenge.
- [82:46]
All right, I think we could go on and on, but we probably should turn to these closing questions questions before everybody stops tuning in. So here we go. What was your favorite achievement from your youth?
- [82:58]
What age does youth go up to?
- [83:01]
Ted Seides
40.
- [83:03]
James Aitken
Good. No, I, I'm going to say getting a single figure golf handicap.
- [83:10]
Nice.
- [83:11]
Yeah.
- [83:11]
All right.
- [83:12]
My handicap today is three children under 13 exactly. Who I love dearly. Keep that in.
- [83:22]
What's your biggest investment pet peeve?
- [83:26]
That from time to time I've pretended to know something that I don't understand. That's my number one pet peeve, is that for too long I was impulsive and reactive and so I'm calling myself out as opposed to what other people do. If I'm thinking about what other people do, one of my pet peeves is people that jump up and down and up and down, up and down, up and down, up and down. And they say, I told you so. Now, maybe I'm old fashioned. If I was providing independent research to people sitting on top of prodigious piles of capital, I could think of no better way than to antagonize them, let alone upset them, by when something I've been predicting for years suddenly happens. And then I say, I told you so or we nailed it. So there's two angles to your peeve. Question.
- [84:26]
Yeah. What teaching from your parents has most stayed with you?
- [84:31]
Been present for your family? Number one, I think about the heroic effort that our parents, dear late mother, put in to the point of exhaustion most days to feed three very hungry sons in Sydney. The shopping involved and the cooking involved. I mean, she was magnificent. And then dad, who had a very busy job, he was always, I know it sounds cliched, but he was always there for us. And I think that's the number one lesson, being present for your family. Not just in the room, but being present. And that goes back to being disciplined. When it comes to technology, you can't lecture two preteen girls about the evils of the iPhone, which I sometimes do. If you're walking around your living area with an iPhone in your pocket, it just doesn't work. So the number one lesson for Mum and Dad was being present. And there's nothing more important.
- [85:27]
What information do you read that you get a lot out of that other people might not know about?
- [85:33]
There is a tremendous amount of information in testimony provided to various parliamentary committees around the world. Now, I know that sounds awfully anoract, but I'll give you a very important example. By definition, if I'm testifying to a House of Commons or House of Lords committee, I am doing so under oath, meaning that it's likely to be more reliable than what you read in the Times or the ft, which will be an interpretation of what's happening in the world. In other words, someone else's view of what's happening. And when it comes to social media companies, the House of Commons Digital Media Committee has been holding hearings in London and Washington about the role and activities of these social media platforms. And not just because I'm personally interested in it, but I've been reading the transcripts of these committee hearings and it's absolutely awful. And the sanctimonious hypocrisy, not to mention borderline law breaking, that comes screaming out of these transcripts is just appalling. And it's there in the public domain. And when it comes to Facebook or Twitter or some of these other platforms, there are real problems pending. And I found it very helpful, well ahead of this Cambridge Analytica stuff, to just go to the website of the House of Commons and calmly read it. And it is the most appalling. Now, self indictment's a strong term, but metaphorically, the self indictment that you can read in these transcripts, the disconnect is appalling.
- [87:23]
What life lesson have you learned that you wish you knew a lot earlier in your life?
- [87:28]
That as much as I liked to read from a very young age, I should have done even more. That's the number one. Yeah, that's the number one. I could have done so much better. I could have been so much smarter. Related to which, with the way I approach things, I could have been so much smarter with process discipline. Things as seemingly mundane as getting up the same time every day, doing the same thing over and over again. And I'm glad we kind of almost by accident got into this. But the common thread across all the most successful investors I have the great, great fortune to work with is their absolute obsession with process. Absolute obsession. If they've got three offices around the world, good for them, but they're identical. And having that comfort, knowing your process, doing the same thing every day for decades. The pen's in the same spot, the mouse is identical. I mean, it sounds inane, but it helps you be anticipatory and remain in control in what remains a very, very emotional and often hyperventilating world. So, two things, Ted. I wish I'd done even, even more reading across all sorts of topics. And I wish I'd paid greater attention and been more disciplined with how I allocate my time every single day.
- [88:47]
James, fantastic. Thanks so much for the time.
- [88:50]
What a treat, Ted. I mean, who would have imagined that you and I'd be doing this even six months ago?
- [88:55]
Amen to that.
- [88:56]
Look, it's such a pleasure and such a treat, and I can't thank you enough for inviting me on.
- [89:04]
Ted Seides
Hey, before you take off, I've started sending out a monthly email that shares a small selection of what caught my eye over the month. I get a lot of emails like this, and I'm sure you do, too. So I'm only going to send no more than a handful of the very best things that caught my eye. If you'd like to receive that email, hop on my website@capitalallocatorspodcast.com and join the mailing list.