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Capital Allocators – Inside the Institutional Investment Industry
Top 5 of 2024: #1: Scott Bessent - EP.415
01:02:52
We're counting down the top 5 episodes of 2024. The top episode this year is perhaps the most timely of our 500 as well. It's Episode 415 with Scott Bessent, a brilliant macro thinker and the cabinet nominee for Secretary of Treasury. The...
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- [00:00]
Ted Seides
We're counting down the top five episodes of 2024 and are ready for number one, which is already the second all time leader in downloads after last year's number one, Seth Carman. The top episode this year is perhaps the most timely of our 500 as well. It's episode 415 with Scott Besant, a brilliant macro thinker and the Cabinet nominee for Secretary of Treasury, the position created by Alexander Hamilton. I was an investor in Scott's first hedge fund, a partner of his for four years, a friend for more than 20, and a huge fan. I'm excited for Scott and for our country about what his appointment might mean for our economic future. Please enjoy this replay of my conversation with Scott Besant.
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Capital Allocators Team
Before we get going, we have some exciting news at Capital Allocators we're hiring we are looking for a Head of Business Development to really lead all relationship building efforts with you, our community, the followers in the institutional investment space. The role will involve all aspects of external facing engagements. That's our gatherings, whether it's our summits or our universities. From planning to leading correspondence with managers and allocators, to marketing the events that have open registration to hosting. The role will also collaborate with existing sponsors and establish new sponsor relationships and then the role will take on any new initiatives that arise. We're always experimenting with new things and we anticipate this person being a leader in those new initiatives. Ideal kmates are someone with 5 to 10 years of experience in financial services or investment management, especially in client facing roles that could be investor relations gap intro, maybe it's software sales to institutional investors. Really what's most important is that this person is passionate about our mission of bridging knowledge gaps and making valuable connections for institutional investors and with without question they are a fan of the podcast. The job spec is in the show notes. If you're interested in learning more and applying. It's also on our website@capitalallocators.com about that's capitalallocators.com about. Scroll all the way to the bottom of the page. Thanks so much for spreading the word about Capital Allocators and our Head of Business Development Job Opening.
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Ted Seides
Hello, I'm Ted Seides and this is Capital Allocators. This show is an an 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.
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You can join our mailing list and access Premium content@capitalallocators.com All opinions expressed by.
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Capital Allocators Team
TED and podcast guests are solely their own opinions and do not reflect the opinion of capital Allocators or their firms. This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. Clients of capital allocators or podcast guests may maintain positions in securities discussed on this podcast.
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Ted Seides
My guest on today's show is Scott Besant, the CEO and Chief Investment Officer of Key Square Group and a renowned global macro Investor. Scott's 40 year investment career has included two stints at Soros Fund Management, the first for a decade under Stan Druckenmiller and the second for five as cio. In between, he launched a hedge fund, retired, and joined me at Protege Partners when he learned that retirement wasn't for him. Following his second tour at Soros, Scott started Key Square with $4.5 billion, making it one of the largest hedge fund launches in history. He's been profiled in two bestselling investment Steve Grobny's Inside the House of Money and Sebastian Malaby's More Money Than God. Our conversation covers Scott's investment path, learning research from Jim, Roger short selling from Jim Chanos, global macro investing from George Soros and Stan Druckenmiller, and twice hanging his own shingle. We discuss high conviction ideas, asymmetric asset selection, position sizing, risk management, a hub and spoke approach and core challenges of the global macro hedge fund business. I once told Scott that he could read the newspaper six months ahead of time because I'd never encountered someone with his ability to connect dots and imagine investments others hadn't considered. His interest in improving the country's economic picture has led him to shed his publicity shy nature and I'm grateful for the opportunity to share his story. Please enjoy my conversation with Scott Bessant.
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Scott Besant
Scott, great to be with you.
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Good. Good to see you too.
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Why don't you take me back to your early experience as a kid that led you to thinking about finance?
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Well, you know in Little River, South Carolina, the only thing you knew about Wall street was something bad happened in 1929. My dad had a lot of financial ups and downs. He was a real estate investor boom bust mentality. And he went bust twice. So that makes me think a lot about risk management, allocation, leverage. The other interesting thing about my dad was he had the largest science fiction collection in South Carolina. Probably not a high bar, but as a kid I could point to Alpha Centurion on a map before I could point to Chicago because he'd sit and read these books to me, would go outside and look at the stars. And one of our neighbors had an observatory. And it was all about imagination.
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How did that lead to your interest in investing?
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I don't know if it led to my interest in investing, but it led to my methodology in investing. Bruce Kovner has this great saying. I had the ability when you and I were together for the subprime trade to imagine that what had never happened before, a national recession in US Housing could happen. That this mortgage rut had permeated the system and that there was this newish form of instrument that could capture these asymmetric returns that took imagination. We had a very distinguished mortgage manager come into the office. I think he'd actually written the Wiley book on mortgages and tell us what a great buy mortgages were halfway through the crisis and I think his fund went down 100%. He couldn't imagine that this could happen or that these tranches in the CDOs could be wiped out.
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So you're looking at the stars, imagining what the world could happen. How did you get started in your career investing?
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I have found in my life some of the best things happen after the worst things. This was not a cataclysmic event in my life, but I'd worked on the Yale Daily News when I was at school. And back then Yale Daily News was an instant ticket to the New York Times, Washington Post, Time magazine. I didn't know whether I wanted to be a journalist or go into computer science, which when I arrived at Yale, it was the year that they switched from punch cards to screens. To put it in perspective. I ran for editor of the Yale Daily News. I didn't get it. I proceeded to lock myself in my room, come out for classes and meals. Woe was me. That was end of October. I came back in January and thought I should reboot complete serendipity. I went to the career advisory office and there was a notice from a Yale alumnus, Jim Rogers. Analysts wanted do spreadsheets, make lunch, clean the toilet. Sofa available to sleep on. Please apply. And I applied for that. It was kind of everything I liked. It was very much like being a journalist. You were creating a narrative, you did some research. It also appealed to the quantitative side. So I learned how to do spreadsheets. It was a great experience.
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So for perspective, who is Jimmy Rogers? For those who don't know.
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So Jim Rogers was George Soros original partner at Quantum Fund. They'd been at Bly, Schroder and First Eagle together. George was more the pm. Jim was the research analyst. I think they split up in 1981 and Jim was managing his own money. So this was just in his family office.
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What was his approach to investing?
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Research, research, research. He always said that he was looking for major secular change. It was dig, dig, dig. Can you prove it? What was very helpful with Jim, like he had come out of the 60s and the 70s. So the 60s were the go, go stock years. The story stocks, the 70s, the nifty 50 and shorting. It was this ability to really dig down and do the numbers match the story.
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Ted Seides
How much time did you spend with him?
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Scott Besant
It was just a couple months. We stayed in touch for a while. He taught an investment management class at Columbia Business School. I commuted in my senior year from New Haven and took the class.
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So as you came out of school, where'd you take that?
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1984, investment banking had just taken off. I didn't really want to do one of the two year analyst programs because by this time I was hooked on the stock market. There was a service called valueline that used to mail out these gigantic books on earnings. You get a trial subscription for $25. So over the years I had a trial subscription. One of my roommates had a trial subscription. Having known nothing about stocks and markets and currencies, I was hooked on markets and I really wanted to do Investment Management. 1984, really, only two firms, Brown Brothers Harriman and Fred Alger, would let you do investment management right out of school. So I went to Brown Brothers.
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What was that initial experience like?
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That was eye opening for me because it was the first time I ever saw relative performance. I was a neophyte at this, but with Jim and then like the Soros tradition, it was high performance. How much can you make? And this the big decision for the month. Are we going to buy Ford vs GM, Citibank vs JP Morgan? It was some good analytics, but it really wasn't my thing.
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And then the next step, I went.
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To work for this Saudi family called the Olayans. They were fantastic. The father had come from nothing in Saudi and built an incredible industrial empire in Saudi Arabia based on supplying the oil industry. At that time, a lot of Middle Easterners had a bad reputation for movie stars and models. They were just the opposite. They were interested in meeting finance people and business people and learning about business. It was a fantastic opportunity. I worked for the daughter of the family, who I'm still great friends with. We were a small team, but we would file 13Ds on companies, which meant we owned over 5%. There were five of us. I'm 23, 24, 25 and I'm sitting across the table from Arman Hammer. I'm sitting across the table from Louis Preston who was at JP Morgan. I'm sitting across the table from all these CEOs and getting all this great exposure and also getting great exposure. People like Leon Cooperman, Byron Wayne, Ray Dalio used to come in and sell us this newsletter.
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So you start with this sort of broad internship with Jim Rogers and then you have the relative value and now you're seeing all kinds of stuff. How did you assimilate all the different things you might be able to do into what the investment approach and what your responsibilities were with the olance?
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What was good there was we got to do everything. So we were doing the research, we're managing the portfolio. Two of us were doing the trading and we had a big options book. 2 I went back and took a lot of option pricing theory classes on weekends and started trading options and futures too. So it just made you realize there are a lot of different ways to come at the investment business because they were very concentrated. They wanted to know the management. Well, they were great and still to this day are great long term investors. But you could goose the returns with leverage with options. So it was a fantastic experience.
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What was it that led you to.
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Leave the mid to late ish 80s? There was kind of this tradition of management breakfast that Goldman Sachs, Morgan Stanley would host a management breakfast for a company. And over those years I'd gotten to be friendly with Jim Chanos, noted short seller also he and I I don't believe ever overlapped at Yale, but like with Jim Rogers, we had the Yale connection and I just found that we were very simpatico in our questions. I would say the difference is that Jim is a pessimist. I am a cautious optimist. It was kind of back to the Jim Rogers mold of just deep dive research and does the story work? I concluded that I thought short selling could become an asset management category and I thought GEM could be the white shoe brand in it because a lot of the short sellers were these shadowy figures and planning stories and just generally had a bad name. And I thought that Jim could become an institutional brand and I was the first analyst, the third employee.
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What year was that when you joined Jim?
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It was after the crash of 87, so I joined in September of 88.
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What was shorting like back then?
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There was a lot more opportunity in terms of dispersion. There wasn't the basket trading, there wasn't the concentration in the indices. But it was a lot spicier before the crackdown by the FCC on frauds and things like that. It was a target rich environment and there'd been a lot of changes. There was the big Reagan tax changes. The Texas oil bust was in the middle of happening. There was this asset appreciation cycle that was led by Mike Milken and all the Drexel companies leveraging up. It was a great time for stock picking. I joined him in 88. And then the Drexel financed bid for United Airlines fell through. I think we made 10% in a month. And then the savings and loan real estate bubble started unraveling. So 89 and 90 were fantastic years to be short financials. So it was the end of this financial engineering through savings and loans. Drexel Burnham went under. The cherry on the MASH of that day was Saddam Hussein rolled into Kuwait. So you had the Iraq Kuwait invasion. I'm cuffing the numbers, but maybe Citicorp went from 32 to 4. And one thing that really stuck with me was a lot of times when there is a bad reaction, you get an equally and opposite misguided reaction on the other side. So the savings and loans had gone under in 89 and were really 90 and had to be bailed out. The bank regulator, the controller of the currency fellow named Clark, panicked in 1990 and did this supervisory tightening and told the banks, even if your borrowers are current, if it's a see through building, you got to write it down to zero. That was really my first go with seeing how bad policy creates good investment opportunities.
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What was the difference between alpha and beta? So it turned out you joined Jim right at a time where there were some more pain to come in the markets. And then things turned. As you look at that period of time, target rich opportunities, but also things kind of falling off a cliff. How did you think about the value added?
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The value added was could you be in something that could go to zero? Because there were plenty of these situations that went to zero. Maybe in 1990 the S&P was down high teens 20 and we were up 50. If you think about the opportunities that there's the market beta, there's the industry group and then we had plenty of stocks that went towards zero.
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Did you look back after that period of sell off, say starting in 92, 93, you have this big bull market. How did you think about being a dedicated short seller as that was turning?
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Oh, I didn't have to. I left in 91. That was excellent market timing.
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So things were going really well. What led you to leave?
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I believe it was January of 91. I think Saddam Hussein finally rolled into Kuwait and the market took off and things had gotten super cheap. And we'd also taken in a ton of assets, as you know, Aum Chases performance. So everyone wanted to be short. I think when I got there, we had $37 million, 38, 13 in the partnership, 25 managed account from Soros. And then when I Left, we hit 500 million. Got at a point I went into Jim and I said, jim, I can't find anything to short. He said, well, that's what we do. I said, well, then I think I'd rather do something else.
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What was that next pivot then?
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The next pivot was we were actually sitting in the Soros offices. I had developed a relationship with the Soros people. So Stan Druckenore asked me to join Soros in 92.
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Soros was always known as this great macro manager. How do you define what that means?
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We back up for a minute. Kind of the Soros, Stan Druckenmore slash Duquesne tradition. Everybody started out as a stock picker. George was a stock picker. He was at Arnold Bleichroeder, and he had a list of 10 stocks. His research process was talking to his clients about his stocks. Somebody convinced him that something was a bad idea, take it off and add something else. And then he expanded into macro. Same thing with Stan. Stan was very young, but he was the head of the research department at PNC bank in Pittsburgh and decided, kind of like my Brown Brothers asset allocation, he just threw away the asset allocation Matrix and put 40% in oil stocks or something in the 70s. He was also a stock picker. I think macro permeates everything. And my style, still the Duquesne style, is that the micro drives the macro. So we can get a huge amount of information from what companies are telling us. We can't predict the PCE deflator better than anybody. We can't have a better model for lei. But if trucking companies are telling you the business is taking off, then that's very interesting. If Home Depot is telling you that they're having trouble keeping products, very interesting. If you are hearing from bank CEOs that credit cards are getting sour, you can make a lot of good macro judgments with that.
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So there's a lot you can do if you're following equities and then have the world as your oyster in terms of instruments and implementation. How did George and Stan think about how they were going to run money.
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Where can you get the most bang for the buck? So if you think oil's going up, if drilling stocks are really beaten down, then maybe it stocks. If the forward curve is predicting that oil is going to drop over the next three years, then it could be through the futures curve. What's the options market giving you?
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How do you think about that in the context of a portfolio?
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I think you could think about it in terms of a discrete set of opportunities. How do the opportunities interact with one another? When you and I worked together, you and I used to always talk about alternate beta. Someone would say, I've got this great idea in Australia, and then the risk manager would do a correlation and it had a 98% R squared with the S and P. What else is it giving you? Or what's your confidence level? Mike Babozian talks about getting above the 50th percentile and the confidence level, getting more and more confident and making your position bigger and bigger. George Soros has this famous saying, I just need enough information to make a decision. He does not have analysis paralysis.
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How do you think about this trade off of, say, diversification, concentration and conviction?
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If you want conviction and you want to be concentrated, there are times when you might not have a big portfolio. You could end up in cash. That can happen with stock pickers like Seth Corman. You and I shared at one time the Ted Williams book on hitting for people who don't know who he is. Greatest baseball hitter of all times. Hit 400. Fellow from Sports Illustrated went down to see Ted Williams and finally the guy said to him, well, how did you do it? He said, I only swing at strikes.
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In your time at Soros, there was a legendary roster of talent. People know about Stan. There are Nick Raditi and others that may be less well known. I'm curious what you learned from all the different people you worked with.
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The feeling that you are with people who are the best at what they're doing and also the collegiality and the conviviality that they have your back. We had Armenia Fraga who became a legendary central banker down in Brazil. And when Armenia would tell you, this is what's happening in Brazil, and if you were investing, say in a food company that had a big business down in Brazil, or if you had a position in iron ore, then to be able to have absolute confidence in that person and not have to fact check their work, incredible benefit. If you're Michael Jordan, you probably want the shot. But if you're Going to pass to Scottie Pippen. That's fine too.
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And how did Soros amass all this talent?
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He didn't stand it. It's a real management lesson. George really looks at the world in a different way and is a markets animal. I think the greatest investment he ever made was finding stan, because in 1988 he turned over the portfolio, but was still kind of actively involved from the sidelines. Then the following year, when the Berlin Wall came down, he was able to spend more of his time on philanthropy and rebuilding Eastern Europe. Stan really built the team. I got so spoiled working for him. I think the Duquesne employment contract is one page and it said, all compensation is at the discretion of Stanley Epdruckenmore. And I only know one person in four years who's ever complained about being underpaid.
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So what was it about Stan's ability to find and determine who he wanted to have on the team?
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I call it the Enough Rope Principle. So there's this famous sculpture by a French sculptor named Man Ray, and it's kind of a hangman's noose and the title is Enough Rope. And Stan just was willing to give people more and more rope. Sometimes it worked, sometimes it didn't. And you knew very quickly. I started out as a stock picker in Europe and then was helpful on the British pound devaluation. My contribution was just an observation that the British housing market, that mortgages there floated with the base rate, which is their overnight rate. And if the bank of England raised rates on Wednesday, mortgages went up on Friday. If they were trying to protect the pound, strengthen it by raising rates, the higher they took rates, they would be bankrupting the voting public. So I had some success with that. And I think I maybe came back to Stan two or three months later and said, look, I'm in charge of this portfolio. It'd be a lot easier if I could hedge with futures. Do you mind if I hedge with. Yeah, go ahead. Hedge with futures. Then it came back a couple months later, and this is before the euro, I said, there are 19 currencies and a lot of these little markets move up and down with currencies. So could I trade currencies too? And he thought for a minute, then he looked at me and said, yeah, do you want to trade bonds and commodities? I said, yeah, I'll do that. I'm 28 or 29. And he said, great, we'll see if you're still here in a couple months.
- [25:39]
So all of this led to what was maybe the first Very famous large macro trade. When Soros had pushed against the British pound. I know you're on the ground then. I'd love to hear how that all played out.
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May 1992, John Major called an election. It was thought he was going to lose. He has a surprise victory and I love the British system. If you lose, you're going to be out of Downing street in 24 hours. So everything was packed, but he won. John Major was touring. Everyone thought labor was going to come in maybe less market friendly. The market took off. The pound strengthened. But the British pound through this agreement called the exchange rate Mechanism was tied to the Deutsche mark. And this was all the precursor for the euro. So it strengthened then. But then over the summer the British economy started to weaken. I could see the housing market was weakening. It became clear that the British economy and the German economy interest rate profiles were very different, that they weren't compatible in the same interest rate regime. Because of the exchange rate mechanism, the bank of England or the British government had to buy an unlimited number of pounds to keep the pound in a quarter. So if it was an asymmetric bet, we could push them up against the wall and the most they could push us back was 2 1/2 percent. And if the corridor broke, we can make whatever in a day. And we did so it was really, we think we have the facts on our side. And not unlike the CDS in the Paulson trade. It was an asymmetric risk reward in terms of the downside George had had in the 80s, these huge currency gains. And for anyone who wants to follow up, one of the books that changed my investing career, George published a book called the Alchemy of Finance. I think it was 1986. There's one chapter called the Real Time Experiment. He kept a trading journal in a year when he was up over 140% and these currency, the realignments, the plaza cord, the lubricord happened, the things moved 6% in a night. And he would add a 300% position because things really used to trend a lot more.
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So alongside all of this trading and search for asymmetric activity source back then was also known as one of the most successful backers of early talent of investment managers. What did that look like under the Soros umbrella?
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That was great because it's really affected my strategy in terms of the kind of organizations that I like. We were able to have a small, tight knit high performance team but we could leverage our knowledge by giving money out to other managers. So it could be someone who's fantastic at growth stocks. It could be a media person, it could be someone in Japan, it could be someone in Asia. And when I eventually took over at Soros, my philosophy was that a very good manager is someone you're proud to be invested with. They have good returns and you never have to worry about the phone call that things have gone pear shaped. So that's a very good manager for an outside manager. Great manager would be someone who one, two, three times a year, maybe only every other year, would come say, this is a big trade idea, you should have it in your center book, or let me do an SPV for you.
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So at the end of your first run at Soros, there was a lot of change. Stan left and you go and launch what I think was the largest hedge fund at the time, a billion dollars. Invest in capital. What was your initial thoughts of your investment style after all of that experience?
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I think one of the mistakes that I made and over time caused a big philosophical change was never do what the investors tell you to do. Do what you're good at. So when I started in 2000, I was able to raise a billion dollars because I told investors I wouldn't do macro. Macro had become a bad word. Long Term Capital had blown up in 1998, and that wasn't really macro. It was more RV gone amok. And then I think some macro positions had hurt tiger that Soros had had a big drawdown. It was just long, short equities.
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How did you feel that that inhibited you from being able to express investing the way you had learned?
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I think it was just the loss of asymmetry. If I had a bullish view on oil, okay, I'd probably be better off owning crude because I remember at a point I did have a bullish view on oil. And the oil stocks didn't move because they were looking more at the mid curve or analysts were waiting for a price, whereas the oil price was going up. So what happened was I went back to the investors and said, look, we're going to do macro. If you want, I'll take the lock off and you can have your money back. We had a good run after that. But at that point, I'd been working since I was 9 years old. I was 42. I had been financially successful and I was just tired. There are two components to a hedge fund. There's managing the portfolio, running the business. I thought I had an A team on the portfolio side. I didn't have an A team on the business side. So there's always this anxiety. So I thought I wanted to retire. I might have been a professor right out of Yale if I hadn't had a lot of student loans and I wanted to go back and teach. I remember having dinner with Stan and his wife and he said, f you, you'll be back in a year. You can't not do this. And he was right. That was my to come and work with you. A protege. I thought I could be halfway back in with the fund of funds. Model with the best ideas, model. Because for me a lot of it, it's the competition making money. But also what we do keeps you stimulated. A lot of people do crosswords, A lot of people play bridge. I find this just so stimulating. One of my mentors. But Byron Wayne said, I'm going to work until I die. And Byron kept working until 10 days before he died.
- [32:17]
So after that run, I know you were going to go launch a fund again. And then George calls to take the big seat. By that time Soros had gotten big. And I'm curious how you thought differently about a large scale asset pool.
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I went back and I really wanted to see if, rather than size being the enemy of performance, whether you could turn size, freeform capital, so no mandate and the ability to make quick decisions into an asset. And I think we were able to.
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How'd you go about doing that?
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Brought in a good team, revamped the outside manager portfolio, made it known that we were open for business, that you bring us an idea, we will not bigfoot you and go around you. I can give you an answer in three days. Whereas Blackstone or somebody might have to take it to an investment committee with five mem in three weeks and build it. And they came. We had a good internal team and then the hub and spoke system for the external managers was very successful.
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How did you spend your time when you had so much more capital? So many different teams. George hovering, as he was known to do.
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I arrived September 2011 and the bond market in general had just melted down. European bond markets, especially the Italian bonds, were still in melt mode. The idea was for me to reacquaint myself with the firm. It was 320 people to manage. 120 investment professionals and many of them not happy to see me there. So I was supposed to have 90 days to get in the seat, get to know people. The firm I ended up doing, I think five days in the biggest trade I'd ever done was John Corzine's firm. Got liquidated out of their Italian bond position and it was a $3.5 billion trade. I still had the index card that I worked it out on. JP Morgan called us and I was able to say, we'll take the whole trade with the repo right now.
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When you're in a seat like that, that's as big as it gets in the financial world. How do you decide when it's time to move on?
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A couple of things you have to think, what's the level of administration you're doing? Is that impacting your returns? My telos in my career has been, I want to do things I'm interested in, I want to keep learning and I don't want to be bogged down. I don't want my day to be things that I don't like. Every day is not a good day, every week's not a good week, but you want to have good months and years. So if you're on the wrong trajectory, there's that. Then I think that I had some differentiated views that maybe one other person at the firm didn't have. It's a real challenge as we get older to not become more negative all the time.
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So you go to start Qi square. What does key square mean?
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Key square is a chess move. So it's at the end of the game where they're two kings, couple of pawns, and there is one square that the king can go to. And I think about that in investing a lot, there is one thing you can do. It's a simple move. It could be at the beginning of the game, it could be at the end of the game. The funny thing, I'm fine at chess. I'm not great. I don't love it. And I don't think that chess is the liquid markets game. The liquid markets game are cards and backgammon. It is luck. And how are you going to manage the hand you're dealt? You don't know what's going to happen in Israel. You don't know when the Chinese navy is circling Taiwan. Is that a drill or is that the real thing, what you're going to be handed every day? You can have good luck, you can have bad luck, but you've got to manage these things that have been thrown at you. Whereas private equity is much more chess. All the moves are on the board. What is the move you're going to do? It was quite humbling. We had the highest ranked female player in the world come in and I think she played 12 or 13 of us at once. And I was very happy. I was penultimate person still standing. She fortunately didn't do it blindfolded, but afterwards she did this tutorial and she was showing us famous chess moves like she knows chess moves from 1913 from a Cuban grandmaster. You could probably go back and look at some of the things JP Morgan had done or some of the great industrialists. If you're looking at Mellon or Phipps or Rockefeller, they're doing the same things in a lot of ways that the private equity people are doing.
- [37:23]
And that's chess in this cards backgammon analogy. When you're investing now, you're taking on the full macro strategy. From everything you've been through, everything you've learned, how did you set out of what you were trying to do at.
- [37:40]
Qsquare on the investment side, we just wanted to have a couple big positions, manage them well and pick out the big things, try to keep the noise out. We had a small tight knit team and then we had 30 consultants around that. Those are people some I'd worked with since the mid-80s. We probably had three new ones, three out every year. And the idea would be, okay, we don't need a Latin American specialist in the office, we have a great consultant in Latin America, we don't need a Tokyo office, we have a great Tokyo specialist. The other thing, having been on the allocator side, was to be an asset to the partners. So a lot of times we would have a major endowment come to us and say, we're going in on this private equity deal in Brazil. What do you think we should do with the currency?
- [38:33]
I'd love to walk through how you distill your investment process. You're looking for a couple of big ideas. Where do you find them?
- [38:40]
I think it goes back to my dad in the science fiction. What could you imagine could happen now? I remember one of our consultants telling me, there's this guy in Tokyo, used to be prime minister, his name's Abe. He's going to run for office and break Japan out of disinflation since the Fukushima tragedy, which it's easy to remember unfortunately is 311 11. The Japanese yen had strengthened significantly. There's a series of prime ministers. I'd started going there, I think in 1989 or 1990 during the bubble. And it really been more of a trading chop malaise with a general downward trend. The yen had become the most expensive purchasing power parity currency in the world. And when this fellow said, well, Abe is going to break the deflation cycle and here's how he's going to do it. The three arrow program, and it's 2, 22 2% inflation, 2% growth in two years. I went and met him and I believed he could probably do it. It was also a great setup. Back to your question of conviction. The bank of Japan, the way the board runoff was working, he was going to be able to reconstitute the bank of Japan without the Prime Minister being able to appoint new governors. He would not have been able to get the reflationary mindset. So he was able to reconstitute the board in his image.
- [40:16]
So there's a lot of connecting dots to make a big move like that. You can imagine that it could change. But you also had bonds, the widowmaker traded, people shorting the JGBS for years.
- [40:28]
That's a great segue. I had no interest being short JGBs. When I thought about the macro panoply of potential instruments, okay, what are stocks going to do? What's the currency going to do? And everybody, because they had so much scar tissue on JGBs, he goes, well, doesn't this mean JGBS are finally going to go? I said, I don't know. It might mean JGB yields go lower before they go higher. But it was very clear to me that the yen was the ultimate expression and that equities would be a good derivative of that.
- [41:00]
What's the research process to connect all these dots to get to the point where you can have that kind of conviction in a macro trade?
- [41:09]
Just like with a stock trade, we set up the fundamental picture. So this is what could happen to the current account. This is how cheap the currency is if it just got back to the historical level. So you actually have a framework and reference points for where it could go. And then there are technicals involved which, you know, can be very different than stocks. What would happen if the yen started weakening? Could there be a cascade effect? Because exporters have a certain position when you get one of these big, major changes. A lot of times there's been a lot of position buildup over time. I think it was Nassim Taleb who says that lack of volatility leads to volatility. So you're also trying to figure out, okay, where's the market? And not unlike with the subprime trade, we had started putting on a short yen position. One of the brokers had seen us doing it and called and said, oh, well, we have this volume fund that will sell you all the yen puts you want. Great. And I think this volume fund thought they were picking us off because the end had Been very stable. So volume was low, maybe the volume on the screen was four. And they thought, well, if these guys would pay six, we'll sell them as much as they want. So I think they thought we were crazy to buy these things at a six volume. Like with the stock, the yen was bouncing around between 78 and 82. I thought maybe it could go to 95. And then when this thing got in motion, maybe it could go to 105, maybe it go to 115. I remember George and I went up to New Haven. This was a proprietary piece of research that I thought we had. One of the architects of Abenomics was a Japanese professor emeritus in the Yale econ department who had been a student of Tobin's Complete Keynesian. And I think Professor Hamada, he was old when I was there, he was in his 80s now. And we went up and had lunch with him, and he just mapped the whole thing out. And at one point, George asked me, do you think this is going to work? And said, I have no idea whether it's going to work, but it's going to be the market right of the lifetime. That's the thing. The policy decision doesn't have to work, but it can cause a lot of price gyration.
- [43:37]
How do you think about position sizing and trading around something like that?
- [43:42]
I tend to trade in thirds, and a lot of the position sizing is, what's the market giving you in terms of this ball fund wanted to sell us these digital options. They move very quickly. Is there asymmetry in the bull market? What is the market giving you and where's your P and L in the year then? A lot of times we'll keep adding if the P and L is good.
- [44:11]
So that's a very different notion than a lot of people think about, say, fundamental investing, which is that the size of your P and L in a given year will determine your position. Talk me through how that portfolio management methodology works.
- [44:26]
One of the world's greatest stock picker, Warren Buffett. Rule number one, don't lose money. Rule number two, don't forget rule number one. It's really this idea. You earn the right to take a risk, whether it's backgammon or you're at a poker table or playing bridge. How's your chip stack? If you walk in and say, all right, I'm bringing $10,000 to the poker table and that's it, then you're going to bet differently. If you've got 20,000, you're going to bet differently. Then it's 30,000. It's really Annie Duke thinking it bets.
- [45:00]
Curious about the relationship between the duration of the trades and that betting chip stack you mentioned. If you're up on the year, what does that imply about the types of positions you'd take on? So that you'd say, okay, it's January 1st, we're starting it, we're resetting our chip stacks.
- [45:17]
I do that as a discipline, reset the chip stack. And when I'm doing it in December, especially currencies, you'd be making a lot of money in December. You're really whipping them and driving them. And whether it's the traders or the risk team or other people say, well, it's December 15th, we got to start taking this down. It's like, God, boy, this could really go in January. When I look back, almost every time that I've taken it down, it's been the right thing to do because there's always a counter trend.
- [45:50]
How do you think about just the process of risk management so that if you're wrong on a big position, it doesn't blow you up?
- [45:57]
That's exactly it. I don't know because of my dad's poor risk management, whether I'd have a lot more money because I'd be less risk averse, or I've gotten to where I am because of the risk management. Look, the wolf's always at the door. But I'm a big believer in Nassim Taleb's definition of risk probability and severity. When we think about investing in China now, what's the probability that you're going to lose all your money one day? That you're going to have a Russia, Ukraine kind of day, which seemed unimaginable, that Russian equities would go down 95% in a day. So it's always probability, severity. How are you measuring liquidity? Because correlations go to zero when you may think you're hedged. One of my risk management techniques have been, you could be one thing but not many. You can't be concentrated, illiquid and leveraged. I prefer to be liquid and then to use leverage. I try to stick with a set of rules. I want to be able to get out within 24, 72 hours on part of the portfolio.
- [47:15]
One of the most fascinating things I've always found about your career is you launched two of what were the largest hedge fund launches at the time. Best in capital at a billion and then key square four or five. And that macro hedge funds in particular are notoriously difficult to sustain as A business. I'm curious why that's the case, Ted.
- [47:36]
That's a great observation.
- [47:38]
So it really goes back to the.
- [47:40]
Ted Williams and the Babe ruth comparison. Ted Williams 400 batting average and he could see the seams on the ball season after great season. Babe Ruth was a home run hitter, but very low batting average. But the home run came for I think five or six decades. The Sultan of Swat and a lot of macro tends to be more Babe Ruth than Ted Williams. The investors grow impatient, they pull out. You have a big year, big two years, the money comes back in rinse and repeat. I think that we have created a business model that works well for us. We have the general hedge fund, which is family, friends, long term investors, those who judge us more on a three year average. There was a very good study from the Common Fund that said one of the most successful strategies for allocators that when you believe in the manager, and I always tried to do this when I was at Soros or any investment committee that I'm on. When a manager has 1, 2, 3, blow it out of the park years, you pull in some capital, pull it back and when they are in a slump, you add. And I found that over the years the best results that I've given to investors are those who add when we're down. The other thing that we've done in our business is we have a relationship with a lot of larger funds where we will go to them with episodic once a year, maybe once every three years, big ideas. We create an SPV and can leverage up into the situation. And then when that opportunity passes, we give the money back.
- [49:35]
One of the things I've always appreciated about our conversations that I like to tell people is more than anyone I've ever known, it strikes me you know how to read the newspaper six months ahead of time. And I'd love to hear what you're thinking now about what could happen 612 months from now.
- [49:51]
Well, I will also compliment you because back to having great colleagues, you were very good. And I got my nose out of joint a couple of times. It's like you're getting it exactly right. What's going to happen in six months? You don't have the positions. And that was super helpful. And the other thing too is I often think that if I had had the real newspaper, would it have been obvious what the trade is? If you had said, okay, there's going to be this war in Israel, it is going to go on for a year, but oil prices are going to be Lower, that's not obvious. If you were going to say that we were going to have a 7% budget deficit, that rates would go way up, but there'd be a Mag 7, that there'd be a tech bubble. So thinking about what's going to be in the newspaper and then the right investment vehicles, I think the big challenges for the next couple of months are going to be very path dependent on the election. If Republicans, which I'm pulling for, get the trifecta, I think there could be a growth shock and animal spirits are back and maybe the Fed's jumbo rate cut was a mistake. I hope that they don't have to reverse and start hiking, which I think would be a big loss of credibility for the Fed. Then on the other side, if Vice President Harris were to win, likely going to have divided government. Republicans will probably have the Senate and we're going to have to figure out what happens here with a 7% budget deficit that's likely continuing to go up. My strong feeling is that Chinese have moved tactically to stabilize the economy, but that Xi Jinping is a different kind of cat that what we saw in the aughts up until 2012 or 2013 with capitalism with Chinese characteristics or communism with capitalist characteristics. He's a Leninist, so he's not going to allow a clearing function in the market that would allow for a sustainable Chinese economy. Then I think we are in a long term bull market in gold. I think we're seeing reserve accumulation by central banks. I follow it closely. It's my biggest position. And even I was surprised the other day when the Central bank of Poland came out and said that they want to take their gold reserves to 20%.
- [52:27]
And you know Ted, over my career some of my best investments have been when a policy, when a government, when a management is driving 90 miles an hour at a brick wall, you assume that they are going to hit the brakes. So that's how you get the big policy changes. A couple of times I've been in the car when they've hit the wall that's less fun. But I think that many of my best investments have been detecting when you're going to get the policy change. And as I said with President Xi, one thing in the Reagan White House he used to say policy is personnel and personnel is policy. So you always look at whether it's the management or the policymakers. At the end of the day they're human, they want to be judged. Some of them are elected. They want to think about how history is going to remember them. So they are very susceptible to external pressure. And many times, if you have an ongoing dialogue with them, if you observe them for a long time, it's easy to detect when they are going to slam on the brakes, which is also a very good risk control metric, because many times something has gone so far out of equilibrium, you get a very good entry point.
- [53:46]
Are there anywhere else in the world that you're keeping a close eye on?
- [53:50]
Japan, I believe that this could be a secular bull market, one of the few in the world. Abe had great policies, but he also had great stability. And then he was assassinated. Unfortunately, he was out of office when he was assassinated. I believe he would have come back. So now the Japanese are maybe back into this game of musical chairs with prime ministers. And then I think Europe is a big question mark in terms of policy and deindustrialization and especially politics. I would predict that in the next 18 or 24 months, Marine Le Pen, the bete noir of European politics, is going to be president of France, and she's going to be president of France because the alternative on the left is worse than she is. So these populist politics that are a backlash to trade and immigration and also just some very bad choices that have been made by the Europeans. German industrial policy, we're going to sell into China, we're going to use Russian energy to fuel us, we're going to keep a cheap currency because the southern European states, which are now doing much better than Germany, we're going to turn off our nukes and make ourselves more reliant on German energy. I'm very interested to see what the German mighty industrial export machine does over the coming years.
- [55:25]
I know for many, many years you've been a very private person, and recently you've been named as potential roles should Trump win. I'm curious to first ask, how do you distinguish your political views from your financial views and responsibilities?
- [55:42]
That's a great question for the fund. I always do that. There shouldn't be zealots in the market. And a lot of what I'm doing now is just a continuation of what I've done for 35 years. It's the geopolitical analysis, it's macroeconomic analysis, it's following trends. And I decided to come out from behind my desk because I do believe this election, there's a big choice. And we are going to decide whether we are going to grow our way out of this debt burden. And I think we can, through deregulation, energy independence and dominance in the US And A growth mindset. We can get back to growth. I feel very strongly that this is the last chance to grow our way out of this. I also felt very strongly that we're in the midst of a great realignment and of a Bretton woods realignments coming in terms of global policy, global trade. A lot of what I taught at Yale I've been studying my whole life. I'd like to be part of it, either on the inside or the out. And then three, I think that this new Republican Party that's been reconstituted with these new constituencies is the party of the future. It's a melding of working class and business class people. I'm determined that these new constituencies get treated well. I started out our family was very affluent. My dad saw to it that we weren't. And now that I've made it back, so I've known economic anxiety. And I want to see for these constituencies and for working people that things go well.
- [57:25]
So one or two things that's going to happen when this comes out. I guess most likely one of these two parties is going to win. If Donald Trump wins, regains the presidency, where do you think that brings you?
- [57:35]
I'm just working to make sure he wins. There's nothing beyond November 5th if he loses.
- [57:41]
Scott, I want to make sure I get a chance to ask you a couple fun closing questions. What is your favorite hobby or activity outside of work and family?
- [57:49]
That's been modified as I got older. I remember when we worked together I was doing triathlons. I will tell everyone if you have a middle aged cris, don't do triathlons because I have two new hips. I am rebooting my favorite outside of work. So trying to do more lifetime sports, whether it's hiking and walking or golf.
- [58:08]
What's one fact that most people don't know about you?
- [58:12]
I might have gone into politics or the military 20 years ago. I just think I was gay 20 years too early.
- [58:18]
How have you felt that being gay has influenced your life and career?
- [58:23]
It had a big influence. I had an appointment to the Naval Academy that I decided not to take in 1980 and we were broke and so it was free. But Yale was very good to me. I worked three jobs and summers and things worked out. And I think maybe subconsciously one of the reasons I was attracted to money management, the numbers are the numbers. It's not a sales job. You don't live next to clients in Greenwich and they're going to give you commissions because you're at the country Club together. I always thought your P and L protected you.
- [58:57]
And if I could add one more thing, I am probably the most quantitative person you'll ever meet, who's also very religious and very superstitious. I don't think they're mutually exclusive, but a lot of people do.
- [59:09]
I pray and have a rabbit's foot.
- [59:11]
That my quant analysis is right.
- [59:14]
What's your biggest pet peeve?
- [59:17]
Entitlement. I think plenty of people are privileged, but anyone who acts entitled really bothers me.
- [59:26]
Which two people have had the biggest impact on your professional life?
- [59:30]
Stan Druckenmore, probably the greatest investor of all time. It's humbling. Never a down year, but also wonderful mentor, human family, man the charities. And then Byron Wayne. Byron never had children, and as a result, he had a group of us who he doted on, he counseled, he criticized. It was incredible because his mental flexibility was. He never got rigid. I remember after the 2016 election, 10 days later, when Trump won, he and I were having lunch. I said, so, Byron, what do you think? He said, Scott, just to know, you know, where I am on politics. I cried when Trump won. I think the market's going straight up. Who can do that?
- [60:18]
What's the best advice you've ever received?
- [60:20]
You have to believe that anything can happen. You never know how things are going to change. You got to be ready when they change, and you have to be prepared to get lucky.
- [60:32]
So if you've done a lot of.
- [60:33]
Prep and the big event comes along, you're prepared for it. And then the other thing is, I've never done anything for short term money. I always try to think over the long term, is it going to keep me engaged? And there's probably a bigger pot of gold further out.
- [60:54]
All right, Scott, last one. What life lesson have you learned that you wish you knew a lot earlier in life?
- [60:59]
Long term relationships are the most important. One of my college roommates. We've been friends since we were 17. We've been there for divorces, marriages, children's births. And it's just these relationships over your life that are so important. When you talked about what was it like going back to Soros, I was the most popular person in the 212 even when I retired in 05. The great people like Ed Hyman at ISI. You know, Scott, we're just going to leave you on the mailing list list. Because smart people never go away. And I'm still speaking to Stan Druckenmore every day. I'm still speaking to Nick Rodini every day. So all of a sudden when I'm the most popular person on 57th street, it doesn't really mean a lot when somebody disappeared.
- [61:52]
These long term friends are the same people who pick you up when you're down and rein you in when you're getting too euphoric. You did a good job of it when we worked together. I hope I did the same for you. And that's really the key is to stay balanced and have people who keep you in a good equilibrium.
- [62:11]
Absolutely. Well Scott, thanks so much for sharing your insights and good luck with wherever.
- [62:16]
Ted Seides
This thing brings you.
- [62:17]
Scott Besant
Great.
- [62:18]
Thanks Ted.
- [62:20]
Ted Seides
Thanks for listening to the show. To learn more, hop on our website@capitalallocators.com where you can join our mailing list, access past shows, learn about our gatherings and sign up for premium content including podcast transcripts, my investment portfolio and a lot more. Have a good one and see you next time.