Martin Kronicle

Podcast: Play in new window | Download

Sebastian Mallaby spent 3 years and conducted over 250 interviews to complete this book. Among them are George Soros, Stan Druckenmiller, Paul Tudor Jones, Bruce Kovner, Julian Robertson and Michael Steinhardt. I am lucky enough to know many of the managers he’s interviewed and although I’m a voracious reader, Mallaby has dug deep into the history of many stories that have been told before, yet has shed new, and informative light.

This is a long interview (53 minute podcast), but it’s not every day that you can speak with someone of the order of Sebastian Mallaby. He’s been a bureau chief for The Economist and he’s been a columnist of the Washington Post for the past 11 years.

Mallaby is the Director of the Maurice R. Greenberg Center for Geoeconomic Studies and Paul A. Volcker Senior Fellow for International Economics at the Council for Foreign Relations. He’s just written an amazing book on the history of hedge funds called More Money Than God: Hedge Funds and the Making of a New Elite.

I highly recommend this book. It’s long no doubt at 400 pages, but that includes the 60 pages of notes in the back of the book that are worth it alone.

During our discussion, Mallaby spoke with great candor both about the people he encountered, interviewed, and the events he’s delineated in his book: he didn’t play it safe and that’s made for a wonderful dialog. Below are a few excerpts from our discussion.

MM: Do you think that the block trading success for someone like Michael Steinhardt is permissible and ethical before and after SEC Rule 19c-3 had gone into effect since his risk taking had benefits society?

SM: That’s a great and a tough question. On the one hand his success owes a lot to being in this charmed circle of managers who began in the 1970s that could meet the needs of the big institutions who could absorb large blocks of stock outside the specialists. They needed someone on the buy-side to take on inventory.

[If Goldman Sachs has a 1 million share order of IBM for sale, and they call Steinhardt, he's in the driver's seat b/c he knows there is a big seller in the crowd. In order to incent Steinhardt, Goldman Sachs would give him a sizable discount of perhaps $1 share to take the stock from Goldman's client onto his books.]

But Steinhardt would also walk away with more information that was not available to others on the floor. Was it a liquidity-driven sale for a pension that needed the liquidity or was it an information-driven sale by a hedge fund. Goldman, Oppenheimer, and Salomon Brothers were the big block traders of the time.

The liquidity provided by the big buy-side block traders (such as Steinhardt) was a benefit to the market. The crash of 1987 was a sharp reminder of what could happen when their buying power was relegated to the sidelines. So despite Steinhardt getting information that could be construed as “highly personalized” ultimately, it was good for the market b/c of the role that he played. There is a social benefit too. We want entrepreneurs to take risk. To persuade people to buy equities you have to have the provision of liquidity at a moments notice. Who’s going to provide that? It makes a fundamental difference to the price if there’s liquidity.

MM: Were Soros and Rogers lucky having taken on the massive leverage they did in running the Double Eagle Fund for ten years and exacting over 4,200 % RoR over that time period?

SM: I think they were good. (you’ll have to listen to the podcast to hear the rest of the answer).

MM: Do you think the hedge fund structure leads one to shoot for the moon (since they effectively have a free Call option) and they’ll either make 9 figures or go bust?

SM: I think that the Mutual fund model is one that encourages the company to gather assets only. The manager is not being directly compensated for performance. There is more emphasis on the marketing, rather than performance.

[MM: IMO, it's easier to gather an additional 10% in net NEW assets, than to grow assets by 10% organically via performance. I think John Bogle is FOS. Enough is right John.]

Q: Do you think it is incumbent for a manager to short a currency and accelerate the inevitable…in other words…the way Stan And George set the UK free of the ERM b/c the champagne Socialists would not make the courageous decision politically?

A: Yes, I think so. They suffered massive humiliation. The Exchange rate was too high. Once the Sterling was kicked out, we (Mallaby is from the UK) went to higher employment and by one year later they had jobs thanks to George and Stan. I do think that trading can force myopic governments to do the right thing and force the right shifts needed. Just like some traders don’t want to recognize their losers and get out. When Politicians brought the GBP into the ERM, they had a “pride” in that decision and they stuck with their loser well beyond the point where they should have gotten out of it, and it wasn’t until they were forced to get out of it that they recognized it.

MM: What can the retail investor learn from your book?

SM: Traders are obsessive and compulsive about the markets. Retail investors don’t share that level of 24/7 focus.

You might not have heard of him, but you might have heard about someone locking up 7% of the annual Cocoa production recently. He’s the man behind the trade. His firm is known as Armajaro and they are huge players in the physical commodity space, procuring soft commodities around the world for their clients.

The Financial Times ran a story on the delivery called Hedge fund develops taste for chocolate assets.

Excerpt from The FT:

A London hedge fund has swept up a large chunk of the world’s stocks of cocoa beans, helping to drive prices of the basic ingredient of chocolate to their highest level in 33 years.

Traders said that Armajaro, which runs several commodities funds, took delivery on Friday of 240,100 tonnes of cocoa, the biggest delivery from London’s Liffe exchange since 1996 and equal to about 7 per cent of annual global production.

Now, back to the facts…

The title “Hedge fund develops taste for chocolate assets” is a bit misleading, but it sounds a lot sexier than “Cocoa Wholesaler Accepts Delivery For It’s Clients.” The spreads in Cocoa are very narrow, so IMO Armajaro is not employing a “cash and carry” trade right now, and they are probably parceling out their inventory or engaging in swaps.

The day the delivery was announced, ICE Cocoa in the US sold off. Furthermore, taking delivery of cocoa today has absolutely no effect on what happened several months ago. Taking delivery today may be due to higher prices, but it does not cause them.

Ward, who traded for Philipp Brothers (Phibro) has traded Cocoa and Coffee for over 27 years and at one time was the Chairman of European Cocoa Association.

Here is a video of that “jammy dodger” wholesaler…

I love cocoa. I admit it’s one of my favorite commodities to trade too. I own a copy of Helmut Weymar’s Ph.D on Cocoa from MIT from the 1960s.

If you’re a systems guy, that probably sounds like blasphemy b/c you’re supposed to look at everything “as a 1% risk unit” so you become indifferent to any particular commodity. But that’s bullsh*t. Anyone who believes that is just parroting Seykota or something else they’ve read in Market Wizards. I find it hard to believe that anyone actually “lives” that. I don’t and I didn’t when I traded 100% systematically.

Martin’s first rule: “Think for yourself. Feel for yourself.”

The contract had an enormous sell-off the day the delivery was announced. However, this is the ICE contract which is priced in USD, not the LIFFE/Euronext contract that was discussed in the news and is quoted in GBP. Here is that chart:

I’ve written extensively about Cocoa here at the famous MartinKronicle, including How To Marry Fundamental And Technical Analysis In Cocoa and How To Trade The Cocoa Trend Reversal.

I met Glenn Yago at the Milken Global Conference and he was nice enough to give me a copy of his book, Financing the Future, which he wrote with Franklin Allen.

Yago Moderated a fantastic panel called Do Our Financial Models Still Work? that featured Aaron Brown of AQR, Stacy-Marie Ishmael of FT, Myron Scholes, Colin Camerer of Cal Tech, and Bruce Tuckman of the Center for Financial Stability.

Here is the full two-part interview which I had to break up because of its size.

Glenn Yago MartinKronicle Interview Part 1 from Michael Martin.

Glenn Yago MartinKronicle Interview Part 2 from Michael Martin.

Podcast: Play in new window | Download

John Authers has written a great book called The Fearful Rise of Markets: Global Bubbles, Synchronized Meltdowns, and How To Prevent Them in the Future and he took some time last week to speak with me about the book.

Authers is a long-time investment columnist. He now runs the Lex column for the Financial Times and is quoted all over the place. He was honored by State Street Institutional Press Awards as the UK’s Investment Journalist of the Year for his coverage of confidence in investment theory.

Here is the blog post by John Kemp on Cash and Carry that I mentioned in the podcast.

I wrote something similar back on February 4 called Oil Barges Coming Ashore that deals with Cash and Carry also.

I consider reading Michael Mauboussin a great privilege.

Here is a pdf he sent me recently called Untangling Skill and Luck.

Excerpt:

For almost two centuries, Spain has hosted an enormously popular Christmas lottery. Based on payout, it is the biggest lottery in the world and nearly all Spaniards play. In the mid 1970s, a man sought a ticket with the last two digits ending in 48. He found a ticket, bought it, and then won the lottery. When asked why he was so intent on finding that number, he replied, “I dreamed of the number seven for seven straight nights. And 7 times 7 is 48.”

If you missed it, I recorded a great podcast with Mauboussin on the heels of his great book Think Twice.