Pod Insights Capital Allocators [REPLAY] Eric Peters – Trading and Evolution at One River (First Meeting, EP.18) About this episode Eric Peters is the founder and CIO One River Asset Management, an investment manager dedicated to delivering high conviction absolute-return strategies, where each individual strategy comes out of the team's expertise in thematic macro, volatility, systematic, and inflation trading/investing. Eric has been a long-time trader and writes a widely dispersed email called Weekend Notes, in which he shares macro insights through colorful anecdotes.
Our conversation starts with Eric's early exposure to trading, macro blow-ups, and the formation and activities of One River. We then turn to the current environment and get his sobering thoughts on what has transpired and what the turmoil will mean for private equity and asset allocation going forward.
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Transcript 10,156 words · 3 speakers
Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.
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3:32 Ted Seides? Hello, I'm Ted Seides and this is Capital Allocators. This show is an open 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.
4:04 Ted Seides? My guest on today's first meeting is Eric Peters, the founder and chief investment officer of One River Asset Management, an investment manager dedicated to delivering high conviction, absolute return strategies where each individual strategy comes out of the team's expertise in thematic macro, volatility, systematic, and inflation trading and investing.
4:27 Ted Seides? Eric has been a longtime trader and writes a widely dispersed email called Weekend Notes, in which he shares macro insights through colorful anecdotes. Our conversation starts with Eric's early exposure to trading, macro blowups, and the formation and activities of One River. We then turn to the current environment and get his sobering thoughts on what has transpired and what the turmoil will mean for private equity and asset allocation going forward.
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6:07 Ted Seides? Please enjoy my first meeting with Eric Peters from One River.
6:14 Ted Seides? Why don't we just start with you going back and get through your initial interest in investing, how that all came about?
6:21 Speaker 01 Sure. I grew up and my dad was a Wall Street guy, and I watched him commute for lots of years, and he didn't seem particularly thrilled about doing it. So I was in college, I kind of wrote off that as a possibility, but I did all the interviews. And coming to senior year, I just never had an internship. I'd always started my own businesses over the summers. So I didn't have any exposure to what I really wanted to do. And I figured, why don't I just go talk to a bunch of people who have been successful? And so maybe coming out of that, I'll figure out what looks interesting. And so I just reached out to different friends who I knew some guy's dad was a big real estate investor. And another guy was in international shipping, another guy was in entertainment, whatever.
7:03 Speaker 01 And I begged to sit down and spend a half an hour with each of them. There were some other industries as well. And I kind of, by the time I went through each one of them, they each pretty much persuaded me that I definitely didn't want to do that. They just, everything seemed boring. And by the way, these are really successful guys and their great careers. I don't knock them just for, but for me personally. I meet with a real estate guy and you go, so what do you do? And he goes, well, you know, I borrow money here and then I buy building and then I kind of fix it up. And I, he got a little extra return and he just seemed bored with his life and it seemed, I just knew I didn't want to do that. And, you know, the shipping guy was talking about international crime and I didn't want to do that. And the entertainment seemed like no matter how hard you worked, it was just such a random outcome.
7:44 Speaker 01 So anyway, a buddy of mine, his dad was a trader out in Chicago. And so I went out there and I sat with him. He was off the floor. He'd been a floor trader and, but he'd built a business and had 20, 30 guys working for him. And I sat with him one afternoon and I watched him lose the equivalent of a year of my college tuition. It was kind of quietly over his shoulder and the market closed and he was a very prominent grain trader. And I said, well, wow, that was unbelievable. And he says, so what do you think? I was like, well, honestly, I'm wondering what you did wrong. And he's like, I didn't do anything wrong. I did everything perfectly. He's like, why do you ask that question? That's interesting. I was like, well, because you lost my college tuition.
8:25 Speaker 01 And he's like, no, you know, that's what markets are and you have a process and you apply it consistently and you do your best. But this is a difficult business and in any given day or week or month, there can be random outcomes. But if you're really good at what you do, you know, over time you win. Literally that was it. Actually, I'd gotten a job at JP Morgan in their sales and trading program. I called them up and I said, I'm not coming. And I'd made a little bit of money in college and I just moved out to Chicago and bought a seat on an exchange and started trading corn.
8:52 Ted Seides? How did you learn?
8:54 Speaker 01 I look back at it, it's just funny because I obviously didn't know what I was doing. I was an econ major, business econ major. I read as many books as I could. And the fellow that I just mentioned was a bit of a mentor and. I just got in the pit. I was told if you trade corn, you lose the least amount of money as you try to learn. It doesn't move around quite as much. So that's where I started and I eventually moved to bonds and currencies. I don't think there's any way to learn other than you just, you read and then you just get in there and you try to do it. That was really my process.
9:25 Ted Seides? Were there some formative models, either mental models or quantitative models, that you adapted to using while you were in the pits to not lose as much?
9:35 Speaker 01 I was really intrigued and always have been about trend following. So one of the fellows that I stood next to in the pit in the early years was a disciple of Richard Dennis. So that was my first introduction into quantitative trading. And over the rest of my career, I've always wanted to take whatever I'd learned to do on a discretionary basis and tried to codify it in a way. The early days were just very much about trying to be disciplined around losing money. There were a number of really hairy experiences I had with that. And those were hairy years. It was my own money and you can go bankrupt doing that. And most people do, by the way. So I remember when we went through the process to be approved to trade on the floor,
10:17 Speaker 01 I was in a room with 30 other people and it was like one of those war movies and it's not as serious as war, obviously, but where the person giving the speech said, you know, look around you in a year's time, there are only going to be two of you guys left. And that actually was about right. There were. It was really all about just managing your losses and being sensible and trying to figure out what is it that you see in the market that gives you some type of advantage. The problem is on the floor is you don't have any information, really. You have a ticker that's running across. You're just trading off of emotion and flows and things like that.
10:48 Ted Seides? I have to ask, so what was the hairiest experience?
10:52 Speaker 01 So my roommate worked off the floor and he worked for a very prominent grain trader, who was a fundamental grain trader, knew a lot about different flows and import, export orders and things like that. And right at the close of trade one day, An order came into the pit to buy a whole bunch of wheat and I wasn't paying attention to the time and I took part of the order and the order, I think it was something like fifty lots for me, which was a gargantuan size that I would have turned around and gotten out of right away, or at least most of it. And I think I just was, I probably made some money. I don't even remember specifically, but I probably feeling a little too emboldened and the market closed and then that was literally it back in those days. There was no aftermarket to trade.
11:34 Speaker 01 And so I was like, oh my God, this is a huge position. And I rushed to the phone because you don't have mobile phones. You rush to the phone bank and I called my buddy and I said, what's going on in wheat? And he could just tell in my voice that I was scared. And so he motioned to the guy that he worked for to just make up this fictitious story in some way. So I heard in the background, the guy like, well, the Egyptians just came in for this huge order and the Russians look like they're pulling back from it. And I was like, oh my God, what does that mean for wheat? And he's like, the market's probably going to open, let's see, you know, up hmm, six or seven cents would be our guess right now, but you don't know in a situation like this. And literally Ted, it was like a penny would have
12:16 Speaker 01 put me bankrupt and anything more than that. And the way it worked is if you went below what your capital was, you basically became a slave to your brokerage firm until you paid that off. And that amount of money to me was just utterly staggering. And so I hung up the phone and I just walked. I went for a three or four hour walk. I was like, okay, so I just graduated from college. I'm bankrupt. I'm indebted to this firm for God knows how many years and that's my life. It literally was like the most devastating mental thing to go through as a kid that age. And then I got back a few hours later and bumped into my buddy and he's like, oh my God, I've been looking all over Chicago. I was just completely winding you up. Anyway, we'd actually opened a little lower and I just got out of everything.
13:00 Speaker 01 But you know, you learn a lot about that and just in terms of over trading and you have to go through, I think those emotions to really be in this business and understand what that feels like and have some things go wrong and get lucky sometimes. But that was crazy.
13:14 Ted Seides? So how'd you go from being a trader on your own in the pits to ultimately down the road founding your own investment firm?
13:21 Speaker 01 I'll try to rip through it for you. So I spent two years in Chicago as a pit trader and was was introduced to a pretty senior person at Lehman Brothers who persuaded me that I need to do something more with my career than be standing in a pit for the rest of my life. So I took a job at Lehman in their sales and trading program in New York and was quickly put into the money market business, which is kind of where the leadership from Lehman, they all cycled through money markets. And so I spent a year in New York and then I was offered an opportunity to go to London, working for a terrific guy who was also very entrepreneurial and the business just wasn't well structured there. And the mandate that the head guys in New York gave for us literally was figure out how to make money. That was it. And it was a great time because I was dropped in there
14:06 Speaker 01 just in advance of the ERM crisis unfolding. And I was young and dumb enough to be able to look at markets with a set of baby eyes. And that really launched me into my prop trading career, which lasted investment banks for up through 97, at which point I took a year to go climb mountains, which is something that I had always wanted to do and did it in advance of starting a hedge fund or asset management firm, which was my intent. But coming out of that, I re-entered society, so to say, because I really had locked myself off from everything. I just read books and lived on my own and climbed. And so I came back into a world that had lost its mind a little bit with the dot com mania. And ironically,
14:48 Speaker 01 I developed a business idea while I was just off the grid and that took a life of its own. And so I came back with the intent to start a hedge fund and ended up starting a financial firm with a few partners that we launched in 98, thankfully survived the dot com crash and the venture capital investors that we had actually ended up appointing me as a CEO through a pretty difficult period in that firm's life. And that was my first real operating experience as a business leader and we had a decent number of employees and had to restructure all kinds of things and ultimately sold the company in 2000. And knew at that point that I really wanted to do something that was directly trading. And so my wife and I moved to California and I opened up my quote unquote family office,
15:33 Speaker 01 which is I traded alone in a room and hit the age of 40 and found myself speaking to Maria Bartiromo on television, like not an interview, just speaking to her, speaking on television.
15:47 Speaker 01 And I said, wait a second, I meant for something a little bit more consequential than this for the rest of my career. And so it was at that point that I was introduced to Jeff Grant, who was based in Southern California and went and met with him. And he was the CIO of a firm called Peloton Partners. And their home base was in London, but they had a group of nine people in Southern California. And I went and talked to him and he hired me as a global macro portfolio manager for his multi-strat fund on the spot. And a couple of months later, moved my family down there.
16:16 Ted Seides? So Peloton had, for those who remember, had a great rise and then a spectacular fall. Why don't you touch a little bit on that experience?
16:25 Speaker 01 Well, yeah, it did. I joined in May of 2007 and it failed in February of 2008. I think that the firm was founded in 2004 or five. It was a multi-manager macro fund initially. It became very successful and it was at a time when I think hedge funds were expanding rapidly and assets were growing. And, and so they ended up bringing on managers that were doing things other than just pure macro. And one of them was an ABS trader and then he actually ended up launching for Peloton an ABS fund. And so they had two funds. They had their multi-strat fund and I traded into that. And then they had their ABS fund and that ABS fund was a big bet against subprime mortgages.
17:06 Speaker 01 It was a relative value bet. So they were long a few, three units of AAA mortgages, short one unit of triple Bs levered seven times. And so in 2007, that was enormously profitable. That I think they made 80% or something like that. But that bet went wrong in 2008 because in 2007, the triple Bs went from, let's call it 90 cents on the dollar to 10. And the triple As went from 99 cents on the dollar to 92. So it's a very profitable bet if you lever that seven times. I think that they thought that the triple As would go back from 92 up to 100 eventually. And the triple Bs would go from 10 cents to zero. And what happened was the triple As went from 92 down to 50 and the fund got stopped out and they lost, sometimes levered, they lost their money.
17:51 Speaker 01 It was a very successful firm. I think it won hedge fund of the year award in January of two thousand and eight and then failed in February. So it's about a spectacular flame out as you'll see. And so I've just seen different versions of that trade. And in fact, we have just seen one recently with what's happened. So what inevitably happens, and this is a hugely important lesson, is when people are trying to mitigate a risk, there is an expensive way to do it, which is usually sound. And there are a whole range of cheaper ways to mitigate it in ways where you offset the negative carry of owning that that or
18:31 Speaker 01 owning that hedge, whatever it might be. And when you get a really big dislocation, it is often the case that the people who have tried to offset that carry end up blowing up. And so, quite frankly, when I joined Peloton, I didn't really understand that bet. And I only loosely understood it through time because it just wasn't part of that fund. But that reiterated and reinforced that. For instance, like in our funds right now, we have some long vol funds, and we also even have relative value of all funds. And they've either done really well, or they've protected capital. And nothing that we have done has been with an eye toward taking those types of risks where if something really goes wrong, a bet that should have made money ends up losing a lot of money. We just don't
19:14 Speaker 01 do that. And I think that's super important for people. And every five or 10 or 15 years, investors learn that lesson, and then they seem to forget it quickly.
19:22 Ted Seides? And then so how did you evolve from there?
19:24 Speaker 01 Quickly fond. I just moved my family down to Santa Barbara, California for that job seven months prior. And we had a group then of 10 people out there. There were six portfolio managers, including Jeff Grant, and then our support team. And we decided to start a firm together out there. And so we launched that firm called Grant Capital Partners in, I think it was September of two thousand and eight, same month that Lehman went under. We just barely got into business. But we were supported by some large cedars. It was a really interesting firm. And we did well for the next four years. We built that to over a billion dollar firm. And I think Jeff got to the point in his career Where he'd done what he wanted to accomplish and felt that central bankers were becoming so
20:06 Speaker 01 active in markets that his skill set no longer matched the opportunity set and he decided to retire. And so, you know, four years after launching, we closed the firm. He returned capital and then I started One River with almost the entire team from Grand Capital. And it was interesting because when we went to return capital, I was nominated to go around the world and thank our clients. And five or six of the biggest clients that we had were very kind and said, look, we respect Jeff's decision, but we'd really love to work together with you. They said, we have an alternative allocation. It's a good diversifier for our portfolio, but we don't feel like we're ever going to make enough money in it to move the
20:47 Speaker 01 dial because we, let's say we allocate to 40 or 50 or 60 different hedge funds and they're running on average at a five vol and they charge high fees and we put them together. We end up with a two to three vol portfolio that has high fees is probably never going to make our seven, half, eight percent that we need, even if it is a good diversifier. And so it was just fascinating to me as I had nice relationships with them, but I hadn't really ever talked to them about their business and their business challenges. But I thought, why don't I actually go out and build a firm that can deliver that to multiple clients like that as opposed to just starting another hedge fund that runs at five vol and compounds the problems they already have. So that was the origin of One River. And so every one of the clients that
21:29 Speaker 01 we had initially had a fund of one with us and we would identify what we thought were the most important opportunities, either bullish or bearish that we saw on the horizon. And then they could allocate to one or more of those strategies. And some of them were discretionary directional strategies and some of them were systematic. And, and so that's how we built One River. That was the origin.
21:51 Ted Seides? What were some of those initial big bet strategies?
21:54 Speaker 01 Examples would be one that everyone's aware of is Japanese reflation. That seemed like the type of bet that we would look to make. One of my favorite was Dutch disease. Dutch disease is a kind of a wonky economic term, but it was It was coined years ago, I think by The Economist, to describe a situation where the Netherlands made a big natural gas discovery and it created lots of capital inflows into the Netherlands, pushed up the value of their currency, hollowed out their manufacturing base, and then their natural gas, boom, turned to a bust and their whole economy kind of fell apart. And so we saw something very similar unfolding with the leveling out of the pace of Chinese urbanization. And so Chinese urbanization created this huge demand
22:36 Speaker 01 for natural resources, not just in one country, but globally, whether it's Australia, or Brazil, or South Africa. And so we saw a much more widespread phenomenon developing, and we felt that as soon as that demand curve even leveled out, forget about reversing. We thought that those emerging markets would suffer profoundly. So that was a really good theme that we had. We had some other ones, like Potemkin Village, which was betting against Russia at the time. They had just had the Olympics, and it's not infrequent that countries can kind of peak in terms of their capital markets once they get past the glow of the Olympics. And so a big, kind of, I'd say, multi-year themes like that. We had a European recovery theme, kind of a balance of bullish and bearish themes, but those are the examples.
23:18 Ted Seides? And then why did you evolve that into what you're doing today?
23:23 Speaker 01 We think of the world thematically, and then to the extent we can take things that we do and lessons that we've learned on a discretionary basis and codify them, we still have the ability to work with very large institutional clients in a fund of one format. And one of our largest clients, you know, is a $250 million client with a fund of one, for instance. But what we decided to do is take a number of our strategies and roll them into more traditional commingled funds. And the reason for that is twofold. One is that we think we have a number of strategies that will endure through time, we think can be good portfolio building blocks for our clients. It also is the case that having commingled fund is just easier to bring lots of different investors and
24:06 Speaker 01 different size investors into a vehicle. But there were also, interestingly, some challenges that might be interesting. The large allocators that we had, who were our early clients, tended to be very aggressive in terms of wanting to express market views and tilt their portfolios in a particular direction. There is a much, much bigger group of interested investors who love the idea of being able to tilt their portfolio with the types of themes that we developed. But when push came to shove, we looked so different that they didn't have the investment team infrastructure to actively make those tilting decisions. So if you have a whole team built around, let's find the best managers in the world
24:49 Speaker 01 and build a diversified portfolio and figure out how to make that fit together and then measure those risks and understand those risks. That's great. That's a really hard thing to do and it's a really hard thing to do well. And then to take an oddball manager in a way and say, and now let's take one river and take that portfolio and tilt it. Question is, how does that fit into the overall risk framework and who's making those decisions and the time decisions? And so what we encountered were a lot of large allocators that were fascinated by what we did, like talking to us about the world and themes and what we saw around the corner, but ultimately weren't making the big capital allocations. And so we made the decision to just look a little bit more traditional, albeit with multiple processes.
25:32 Speaker 01 We have five funds now and maybe over the years that will grow as we figure out really good things that we can do. The irony is, we converted to this model and we ended up getting six or seven really notable global endowments. Couple of the largest US corporate pension plans were approved by a couple really notable US consultants. Now, like our whole world just changed after having made that transition. And now we have some of the strategies that we can recombine in ways that I think will be a really fun part of our business over time.
26:03 Ted Seides? So what are some of the strategies and themes you have in these vehicles today?
26:08 Speaker 01 So we think in terms of strategies, themes would be embedded into our discretionary strategies. It's just kind of how we think about the world. So we have a dedicated long volatility fund. So it's a discretionary fund that looks across asset volatility globally and looks for what we think are the best opportunities to be long vol relative to what's happening in the world and relative to what we think are the potential catalysts. And so that's a fund that we run. We run a fund called Dynamic Convexity, which is also long volatility, but it is a purely systematic long volatility fund and only equity. So it doesn't trade cross asset vol. Dynamic convexity, we talked a little bit about quantitative investing earlier on.
26:52 Speaker 01 It's super exciting from my perspective and a career perspective because it's taken three different investment approaches that we've had in owning equity volatility that we have traded for years. And it's codified them into something that's purely systematic and not only puts risk on, but takes it off and takes profit and crystallizes those profits based on what we think is sound trading logic. And so that's a great allocation for people to make that want to have some type of really thoughtfully constructed systematic convexity solution next to maybe the risk premium portfolio or next to their equity portfolio, or quite frankly, next to their trend portfolio. So it works really well together. So those are the two long vol strategies. We have an RV volatility strategy.
27:36 Speaker 01 So it's purely market neutral and it is market, it's flat on the air. But we're looking for cross asset idiosyncratic opportunities in the vol space. And I think coming out of this crisis, it's going to be a very target rich environment for a strategy like that because there are so few players left in it. And whenever you start dislocating markets like this, the people who can manage the risk well through the difficult times, I think really, you know, and rightly so, get rewarded on the backside of that. So those are the three volatility strategies we have. And then in trend, we've been running a systematic trend strategy, which took me back to those early Chicago days. And something that was really exciting for us is one of our largest Australian superannuation clients last year came to us and said, We like your approach to trend.
28:21 Speaker 01 Everything we do, we think, has really thoughtful risk mitigation embedded into it, including trend. Where we have certain stop-loss methodologies that get us out of the way of really big market reversals. And so they said, we like what you're doing. If we gave you a hundred million dollars, could you apply your algorithms to alternative markets? And we had been doing research on that for about a year and a half. We knew it would be one of the products that we would want to do. And so we were able to launch that last year. And so that's our fifth strategy. So we have core trend that's outperformed the industry. And now we have one of the few alternative market trends out there. And because we've been trading macro our, our whole careers, a lot of these instruments are just pretty straightforward for us to trade. And so that's been a really nice addition.
29:00 Ted Seides? How do you think about what your edge is or competitive advantage in these trading strategies?
29:06 Speaker 01 I think we apply what I would say is just a lot of common sense to what we do. We want to always understand why we're getting paid to do something. For instance, in trend, I absolutely respect guys who can make money in short-term trend trading. I don't understand why they're getting paid to do it. I think that we get paid to trade long-term trends because the world is always changing. And there are certain times in history, it's changing more dramatically and perhaps quickly than in others. But the world is always changing and it's difficult for humans to wrap their heads around change. And so that is often why trends extend well beyond what people can really contemplate or imagine.
29:48 Speaker 01 And markets and economies and innovation and politics all move through cycles. And they don't tend to be super short-term cycles. They tend to be longer-term cycles and weather and everything I observe in nature moves through cycles. And so I think that the reason you get paid is because the world does move in cycles. And yet people struggle to understand the breadth and magnitude of change. And so if you can ride a trend for a long period of time, there's a good chance that a lot of people, even if they're super smart, will have gotten in it, but get out of it way too soon. For instance, when 10-year treasuries got to three and a quarter yields, I can't tell you how high the percentage of friends that I had who are discretionary traders, and I am as well,
30:31 Speaker 01 who thought they probably don't have a whole lot of upside, but they have a lot of downside from here. Yields could fall a long way. And they were short above 3% and they were typically out at 275 or 280 and declaring victory. And now we're, whatever we are, 70 basis points. And I've watched people blow up over the years with the JGB Widowmaker, where you just couldn't believe that rates could go as low as they have. And so these are just examples of things. So we trade in medium to longer term trend because we think we understand why we get paid there. And yet the trade off there is that if you're trading longer term and you have major market reversals, you can get really profoundly hurt. And so I don't like that. I just don't like losing a lot of money and being vulnerable like that. And I hate negative convexity.
31:15 Speaker 01 And so we have embedded stop losses within everything that we do. And that gets us out of the way. We got to have all of our equities in the second half of February. And so we thank God, but that's why we've built things the way we've built them. Now, one of the challenges for us is it limits our capacity. So our big competitors, they've made the choice that they're going to build strategies that can manage 10 or 15 or 20 billion dollars and they can't get out of the way. But my view is I'd be very happy to build a business where we're great fiduciaries and we have good risk mitigation, but we're not as big as the other guys. And Vol, we've been doing it for a long time. They're very complex markets and I think we're very cognizant of risk.
31:59 Speaker 01 I think that we work very hard to understand all the flows. That's helpful. I think we're super curious. I think one of the things that's underestimated in investing is just how important it is to have an open mind and be really thoughtful and curious about what are the things that maybe you don't understand that well? And what are the potential risks embedded in that? You can go through long periods of time where that's not super important. And then you get to a period of time like this. And if you're not those things, you get wiped out. You lose your business, you lose your money, you lose your investors' money. You might lose all of it, or you might just be so impaired that you can't be around to play again. Those edges are really underappreciated until you have these periods. And then I guarantee you in three or five years, people won't be that worried about stuff like that anymore.
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34:04 Ted Seides? I want to turn to this last couple of weeks and period of time. So as we sit here and it's Wednesday, what are you seeing in the markets?
34:15 Speaker 01 I just think what's happening in the world is utterly fascinating right now. The thing that's most interesting to me is humans just have a very, very difficult time processing rapid change. And I'm not immune to that, but I think that creates opportunity because what we had is we had a very rapid equity market decline that I think is entirely justified. Number one, because I think equities were just enormously overvalued to start with. And then we had this chaotic decline that the Fed stepped in to try to mitigate. And in the absence of what the Fed and what the government have done with this, I think the equities would be down 30 to 50% from where they are right now. Now, the Fed has
34:57 Speaker 01 done what they've done, and this government package is in place. And I think that they're material and they're meaningful. But when I look at it... I think we now have a whole range of second order effects on society and on the economies and on markets that are extremely difficult for people to process. And I think that's where some of the really good opportunities are going to come from. And then, once we get through the second and third order type shifts that are going to happen, then investors are going to look at their portfolio. And then you have this whole new round of challenges. How do you build a 60-40 portfolio when the Fed has taken the whole curve to zero or close to zero and doesn't move? I don't know. Go ask the Japanese how well that's worked out
35:42 Speaker 01 for them. We haven't had to confront that in the West because we've had an actual curve. Even if rates have been low, there's been some ability to have your Treasury investment offset some of the risk in your equity portfolio. And that's allowed people to take lots more risk to hit the magical seven and a half percent pension return. There's no way pensions are going to be able to even come close. They're not even going to be able to pretend that they can anymore. And so what are the repercussions of that? So there are a lot of things that kind of just starting to think through. In terms of the market here and now, I think we're a lot closer to the ceiling in terms of equity prices here than we are to the floor. I think it's highly likely that we'll be a lot lower in equities before
36:24 Speaker 01 this is over. And there'll be pockets of opportunity in vol. Equity vol could still go up from here, but the real convexity is behind us in equity vol. But there is a lot of convexity still in certain currencies. And then I think some other things that we're looking at.
36:39 Ted Seides? So as you look out past that period of time, say, two years, three years, whatever it is, you mentioned pretty significant effects on the economy, society, and markets. Why don't you walk through your thoughts on each of those?
36:53 Speaker 01 Let's start with just quickly what got us here. I think what got us and why we have been calling for market fragility, when I think a lot of others have been relatively sanguine. What I've observed over the course of my career is that crises are always different and policymakers are always fighting the last war. And people, people say that a lot, but I don't think that they appreciate how important that is. And it's important because if that's true, then you can rest assured that the next crisis is always, it's just going to look different. And so I think what happened after oh eight is that people concluded that the banking and financial sector just got way over its skis and it facilitated this huge run up in property prices. So we have to stop that kind of behavior from ever happening again. And we have to just rein in these banks.
37:38 Speaker 01 And if we can do that, then we're in good shape economically and market wise. And so you'll notice that over the last few years, whenever central bankers are talking about the overall market structure, like, well, look, the banks are well capitalized. And largely speaking, everything's okay because the banks are not engaging in risky behavior and the private sector can handle losses if they do something stupid in ETFs. But the central bank, if they could have prevented the worst crisis since the Great Depression in 2008, then surely as long as the banks are healthy and the Fed is there, there's no way we're going to have a really disrupted economy.
38:18 Speaker 01 And so I think what has happened is that our entire corporate sector and investors have geared themselves toward really low levels of economic volatility because the view was that if the Fed was able to save the economy from oh eight, and if that was truly the worst thing that's happened since the Great Depression, then what else could happen? And so when you have everyone gear themselves to low economic volatility, like, what are some of the things that that means? Well, it means that the corporations look at their balance sheet and they're like, well, if we have relatively stable cash flow coming in and we think that the Fed is going to be able to mitigate any real economic disaster, then why don't we just go out and borrow as much money as the market will let us and then buy our stock back? And so that's what they do.
39:04 Speaker 01 And investors did the same thing because they're like, well, look, we got to earn seven out percent a year. Otherwise, I'm the state of you come up, you name the state. Otherwise, we're insolvent and we can't be insolvent. So we've got to make seven out of percent a year, at least pretend like that. And we can't only own equity. So let's just go into credit and private credit or let's do private equity. And every single one of these things has been fueling and funding this leveraging and financialization of the US economy. And the common factor is low economic volatility. So here we go. Boom. We have this tail event. By the way, it could have been any number of things. This outbreak happens to be, I think, the worst conceivable tail that could have hit because it just stopped the cash flows to all these guys that have over levered.
39:48 Speaker 01 Everyone's over levered and private equity guys, they're the worst in terms of this. But investors have put their money into private equity because they get a levered equity return to try to hit their seven and a half percent target. They don't have to market, not as aggressively. And so no one has been a bad actor, but the pressures that we're all under led to this leveraging of the economy. And so now that's over. So the question I think you have to ask yourself is, will we go back to that type of financialized, leveraged corporate sector and investment portfolio? And I would say that it's pretty clear to me that is not happening. Okay. And so if that's not happening, that means the economy runs on a less levered basis,
40:30 Speaker 01 which makes it more resilient, but less dynamic, makes it more resilient, but slower growth. Okay. Investor portfolios, they're going to run in a less levered way. And that just means that they're more resilient, but the potential return is lower. And that's going to create this cascade of effects because that's just going to make, it's going to make our pension system not only insolvent, but obviously insolvent. I think people pretended otherwise for a while and we're going to confront that. So those are examples of things that I see unfolding.
40:59 Ted Seides? What do you think portfolios will look like? Pick your timeframe, five or 10 years out when this washes through and people have the time or some of these investments just take time to recycle and shift allocations?
41:13 Speaker 01 This is the kind of thing that may make me look foolish. I think private equity is done. I think that it will always be an investment style like it has for, over the course of my career. It was just LBO investing when I started, I guess. Now it's private equity, but there will be people engaging in that. But I think the private equity guys are going to. Come out of this looking terribly because when when we finally go through this and really go through the analysis, people are going to say, holy cow, all these guys went out and bought whatever the number is. You know better than I 25% of all the private companies in America. They bought them. They put how many turns of leverage on this. They borrowed all this money. They pulled that money out for themselves.
41:57 Speaker 01 Of course, also their investors as well, but those investors won't get the scrutiny. So that the guys who run those rooms pulled all that money out themselves. Look at how wealthy they got. And then what happened? The economy stumbled. They all went broke. They fired everyone or almost all the people. And a lot of these companies didn't survive, but they kept on their money. So in that environment, I think to imagine that you're not going to have a lot of new rules, taxations, regulations, I think we will. That's going to be something that looks different. But in terms of big picture around how investors, what their portfolios look like and how they'll invest, I think it will inevitably be with less leverage.
42:37 Speaker 01 The portfolios, my guess is they'll be less complex in lots of ways. So I think one of the other mind tricks that we played on ourselves over these numbers of years is that, and I'm going to exaggerate this, but imagine everyone went to the same university and studied the same book on portfolio theory. And everyone came to the same conclusion, which is there's no free lunch other than diversification. And so everyone tried to enhance their portfolio through diversification, but they all end up doing exactly the same thing. Again, this is a stylized exaggeration of the marketplace. And if everyone does the same thing and thinks that they're diversified in the same way,
43:20 Speaker 01 which is people are trying to create an enhanced return by diversifying their portfolio in such a way that their risk systems make it look less risky so that they can apply more leverage to it. I think we're going to find that the portfolios that applied that logic to the greatest degree are the worst performing. And so that behavior will be significantly curtailed, whether it's through regulation or whether it's through investment committees and endowments and corporates. I just think that it's going to look different in that way.
43:50 Ted Seides? You know, it feels like you have a lot of these conversations that for the last 10 years, people in those seats felt like we were in a low return environment. And part of the reason we've seen that extension into private equity and private credit is exactly as you said, what you're painting is going forward an even lower return environment. And so there's this question of what alternative do people have if they get simpler than they're left with choices that clearly aren't going to meet their spending needs?
44:20 Speaker 01 Yeah, I think people have thought we've been in a low return environment, but historically, I'm not sure that that's been true. It's just, it's been low relative to what the targets that they've set for themselves and the targets that they've set for themselves have been relatively arbitrary. And I think it's a function of what do I need to deliver to make sure that I'm not insolvent as a pension and/or maybe what did I get used to earning? And I want to continue to earn that. I think the problem is there's just too much capital in the world. We haven't had a real cycle of capital destruction. Historically, that's what wars do. They literally destroy capital. We haven't had a depression. In the Great Depression, you got to a point where people were knocking down office buildings and homes
45:04 Speaker 01 because they couldn't get tenants. And the property tax that they had to pay because there was a structure on a piece of land was so uneconomic, it made more sense to knock the building down. And so there are lots of ways to destroy capital. I think we haven't had a real capital destruction cycle. And so when there's just too much capital in the world, and I think that there continues to be, there's obviously a lot of destruction that's happening right now, but there's not destruction of plant and equipment yet. I think that that's coming, by the way. I think that there's going to be enormous capital destruction globally over the next five years or so. But until you get real capital destruction, there's just too much money in the world chasing too few streams of return. I think it literally is that simple. And what the Fed is doing
45:49 Speaker 01 and the Treasury is they're saying, let's just make sure that no one goes broke. And let's make sure that none of this capital gets destroyed. And so I don't see how that doesn't lead to a long period of really low returns. Now, what people do about that, anyone who has relied on investment returns
46:08 Speaker 01 To fund their future obligations has a real problem. And this is going to amplify it because as a society, we clearly have made the choice that we do not want to see capital destruction on a large scale. We want to keep, just like Japan, we want to keep everyone in business for as long as possible. And I get it, like, who wants to see capital destruction? I just think the consequence of that is that investment returns that are available, if there's too much capital because it hasn't got destroyed, those returns go down. And we have a major, major issue around that.
46:40 Ted Seides? It's not the happiest thought, but it's certainly one case. One of the things I wanted to chat with you about, you for a long time have written what you call Weekend Notes.
46:50 Ted Seides? And it is a fascinating perspective and style of some of the very bright minds you talk to. And I was wondering if you could talk through what you view the Weekend Notes to do for you? And then how you go about it?
47:05 Speaker 01 I've been formally writing Weekend Notes for a decade now. It's been one of the most wonderful things in my life and career, for sure. And it's just been tremendous in that I write it throughout the week. It forces me to do an enormous amount of reading. And I try to speak with people that I've cultivated relationships with throughout the industry and throughout policy and strategy groups globally. And then I really try to think about what are the most interesting things that I learned that week? And that I thought about and that I assimilated that I'm thinking about for our portfolios? And questions that I'm asking, and it is a very succinct piece, which is a good discipline as well. And I hate things that are unnecessarily long.
47:51 Speaker 01 And then I publish it and it's been great because it allows people to understand what I'm thinking about. And it allows me to walk into almost any meeting in the world with policymakers or investors and share ideas, but get them to speak. It's wonderful to have that exchange. And so it's helped me enormously understand the world of investing, not just from a hedge fund perspective, but an allocated perspective, but also policy perspective. So it's grown a lot and a lot of the top policymakers and central bankers in the world read it every week and a large percentage of the CIOs at the biggest investment firms, both on the hedge fund side, but also the allocator side, read it every week.
48:30 Ted Seides? Any longtime reader will be familiar with names like Mara and Charlie and Connor. How have you thought about where you keep it personal and where you make it professional?
48:41 Speaker 01 Well, Mara, my wife, she was the youngest editor at the New York Post and the only woman editor at the New York Post when I first met her. And she's an incredible partner and we have four kids and she's always pushed me to just be as real as possible and as transparent. And things I think about at work also affect the way I interact with my family and things that I learned from my children and observation I have apply to what we do. So it's nice to blend those together and personalize and it's helped me enjoy what I do even more, actually.
49:14 Ted Seides? On that theme of personalizing things, I want to turn to a few closing questions. So why don't we start with what's your favorite hobby or activity outside of work and family?
49:23 Speaker 01 I just love the outdoors. I played college sports and so I love sports. I love coaching our kids, which I do and love coaching other kids in town. But I really, I just like getting out in the mountains. The thing that, that I miss having moved back from California to the East Coast here is the mountains, but there's a lot of beautiful outdoor spaces. So hiking, running, riding through the, in nature is, that's my thing.
49:45 Ted Seides? What's your biggest pet peeve?
49:47 Speaker 01 Petty people, pettiness. It's just, none of us are on this earth for very long and people who take themselves too seriously and are just petty, it's, yeah, drives me crazy.
50:00 Ted Seides? How about your biggest investment pet peeve?
50:02 Speaker 01 I think there are a lot of people who are very arrogant and just not introspective when it comes to investing. And investing requires huge amounts of curiosity and the best investors that I know are that by far, they're humble. Maybe they put on a little bit of an air in front of a big group of people, but when you really sit down with them, you know, they're They're super, super curious and passionate and humble and they recognize that they've gotten a lot of things wrong in their career. Maybe they've gotten more wrong than they've gotten right, but they've sized the things that they got right in the right times. And so you just come across real arrogance.
50:37 Ted Seides? What do you do for self-growth?
50:39 Speaker 01 I think writing has been the greatest gift. It's a blessing and a curse. Just because there's a lot of work that goes into it, but for sure, it makes you have to organize your thoughts. And there's a lot of pressure when you have the kind of audience that I have with this. You hit send and you're putting yourself out there in front of a lot of really, really smart, critical thinkers and you just want to be your best all the time.
51:02 Ted Seides? What teaching from your parents has most stayed with you?
51:05 Speaker 01 I'm the oldest of eight kids, so it was just hard work. I always had to earn every dollar that I ever made. And I was just very self-reliant and just by definition, that's kind of what happens. And so those are good things.
51:23 Ted Seides? All right, last one. What life lesson have you learned that you wish you knew a lot earlier in life?
51:28 Speaker 01 That's easy. Maybe starting from my mid 30s, I started realizing how little I knew and how much I could learn from people who just were much more successful than I was and much smarter and just had been through different kinds of life lessons. And then I think Mara did an amazing job of just helping me understand that in order to really engage with those people, I really needed to be transparent and just true about how I feel about things and what's going on in my life. And I really invited some wonderful relationships into my world that are, if they're not direct mentorship relationships, they're just, they're wonderful relationships where we all get something out of it. And I've just learned
52:12 Speaker 01 how to conduct myself in ways that I was just ill-equipped when I was younger. And had I learned that earlier, let me put it this way, I actively coach my kids to help them figure out how to develop meaningful relationships with coaches and teachers and other adults, because I think it's so important. And I just think that reflects how badly I wish that I had done that earlier.
52:34 Ted Seides? Yeah, great. Eric, thanks so much.
52:37 Speaker 01 Thank you. It was really nice. I appreciate it.
52:41 Ted Seides? Thanks for listening to this episode. I hope you You found a nugget or two to take away and apply in your investing and your life. If you'd like what you heard, please tell a friend and maybe even write a review on iTunes. You'll help others discover the show and I thank you for it. Have a good one and see you next time.
53:04 Speaker 02 This podcast is for informational purposes only and should not be relied upon as a basis for investment decisions. All opinions expressed by guests on this show are solely their own opinion and do not necessarily reflect those at their firm. Manager's appearance on the show does not constitute an endorsement or investment recommendation by Ted or Capital Allocators.
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