Fontainebleau

Nick, why do you think the hedge fund industry future might get brighter?

Hedge funds in general have had a difficult time over the last couple of years in a world where financial market volatility has been repressed by all central banks. They also have had to compete with the rise of passive investment products like exchange traded funds which offer much lower fees. In this environment, many funds have either shut down or reduced their fees.

We see two reasons why the hedge fund industry future might get brighter, however. First, after 10 years of interfering with financial markets, central banks seem finally willing to normalize their policies which means active market participants will regain a larger role in the markets. Secondly, the classic benchmarks like the S&P500 should be easier to beat over the next decade both in terms of absolute performance and volatility adjusted ratios. The current market being already 10 years of age, it is hard to believe equity markets will remain as smooth for another decade.

Can the US economy keep growing without another crisis in the years ahead?

The world has never been a safer and more integrated place and we see this trend accelerating despite potential setbacks due to populist policies. Machine Learning, biotechnology and blockchain technology will change the world in the coming decades, making it an ever safer, more rational and business-friendly place. We will live longer, healthier and have ever more leisure time. While this sets the stage for long-term positive prospects, in the short run, financial markets and the economy will have to transition through a much more volatile period because central banks are taking a step back. We suspect the U.S. economy will keep growing in the years ahead but this doesn't mean financial assets will not experience much more volatility as their rates of return have far exceeded the GDP growth rates over the last few years.

What keeps you up at night?

The real elephant in the room is the long-term prospects for interest rates and inflation. Central banks have used and possibly abused policy tools to prevent much short-term pain for many industries which has two negative consequences in the long run.

First, an artificially low interest rate environment for economic agents inevitably means business decisions have not been optimal for long-term growth prospects. For example in the U.S., much of the rising corporate debt has been used to solely increase leverage with stock buybacks. Another example is the case of large European banks and even countries that have been allowed to survive the last great recession without having cleaned out their balance sheets.

Second, by monetizing the deficits, central banks have left the door opened for vey tempting populist policies. We already see a steep rise of the deficit in the U.S. at a time of strong GDP growth. Similar fiscal expansions will inevitably be too tempting to resist around the rest of the world. Eventually, we could see central banks losing control of the long end of the yield curve in a rising inflation environment. This could set the stage for a much deeper crisis than the great recession of 2008.

Rapha, tell me more about the fund? What do you do, and more importantly, why do you do it?

This is a question my Mom used to ask me a lot (Isabelle, this is for you), and so I'll use terms that everybody understands.

Everything that we do comes from the perspective of risk, and obviously, we want to minimize risk. If there is one thing I have learned in finance, it's that there is really no leeway for losing money. If you're in the game of becoming a renowned investor guru like Warren Buffet and George Soros (Nick's mentors by the way), you have to produce results over the course of decades, and never lose money because that would instantly put you out of business.

Ever since Nick started trading, he has been obsessed with preserving capital, because it was both a work instrument and his very own money. So from the start he got interested in the ultimate way to minimize risk in finance: arbitrage. To make a long story short, he developed arbitrage strategies, using statistics and computer algorithms, and was eventually blessed with tremendous results during the subprime mortgage crash and sovereign debt crisis, and more recently when markets were shaken by the surprise election of Trump in November of 2016. These results are even more impressive if you consider that the risk of losing money has always been controlled by a strict minimum: since 2006, his worst year, it has remained flat.

So, how do you make money while minimizing risk?

The fact of the matter is that strategies evolve all the time, as you need to adapt to ever-changing market conditions. Every nine years or so, economists believe a crash is inevitable, and the fact is that you don't trade in a bull market in the same way you would in a bear market. What really matters in the end is the talent your money manager has derived from years of experience. Let me give you an example.

Since the beginning of last year, Nick has been developing a new strategy by analyzing US corporations. The latter are big businesses, be it banks, insurers or other multi-billion dollar companies which are in the business of residential and commercial real estate. Except, he doesn't invest in the companies per se, because that would be too risky for his long term goals of never losing money: company stocks are volatile and vary depending on the sentiment of the market and based on declared quarterly profits. Rather, he invests in the debts of these companies, and not just in any debt.

First, his algorithms detect a particular type of debt. In a perfect world, these debts should have cancelled by the company and replaced by newly reissued and lower yield debt. By not cancelling these high yield debts, the company leaves money on the table, in the form of high dividends. The markets often value these debts as if they were indeed just about to get cancelled, and make them less expensive to invest in. These situations persist, sometimes for years, especially if the cost of reissuing a new debt is high.

Second, his programs continuously capture these high dividends while controlling for other classic market risks. The best part is that if the company eventually decides to stop paying this high yield debt, then capital is still preserved, simply because companies are bound to reimburse investors at 100% of face value.