True Diversification: Allocating Capital Effectively (w/ Raoul Pal & Dylan Grice)
DYLAN GRICE: In terms of what I was saying earlier, I knew this business, I knew this company and I've been invested in this bank on and off for several years now, ever since the crash in late '14. When you said you should be buying what you know here, and you should be doing your work. Some of the other things that I've actually-- one of the things that I think we did quite as we pivoted for value investors, we actually got quite bullish on tech and stuff some time ago. We got comfortable to the idea that things which are optically expensive are not necessarily intrinsically expensive. We then get some good-- we did quite well with some tech names and some growing names effectively. Effectively, we're buying some good stuff. I think that some of those names just got absolutely smashed, and they are now penetrating it, but not necessarily the headline, Facebook, Amazon, and Google, but you could do the wrong-- I said booking.com, I think that's a very good example of a company with just absolutely bulletproof balance sheet, bulletproof as bulletproof as you get a business model, just rolls off cash, dominates its market and it's still getting double digit growth, and it's still would be around when this corona thing wears off. Again, I look at that, and I can see, on a proven case, I can see double digit returns on a 5- to 10-year view. I think more likely, you're pushing 20% returns. I think when you're looking at some of these names, some of the things that-- I say that's not CLO-- RAOUL PAL: Sorry, when you say 20% returns per annum, you're talking about that over a period of time? DYLAN GRICE: Expected annual return of about 20%. I think I've talked-- for select names, I know I'm looking at 10% to 20% I think, but that doesn't mean that in six months' time, there won't be an expected return of 30% or 40%. It makes sense to buy them now. It makes sense to see actually, that valuation works from me here, and therefore I'm actually, okay, yes, I'm scared about how far this goes. Yes, I'm scared of a credit event. Yes, I'm scared that actually when the shit really hits the fan in the US, there's going to be mass panic, I get all of that, but that's still enough for me to be doing the right thing. RAOUL PAL: But that works PA, and it works in a family office but in an asset management business, that doesn't work. Because most people can't afford to take pain for a period of time. Pain is, as we know, all of the greatest macro traders in the world can take extraordinary pain because what they're looking at is the risk versus-- they already understand that, but the average investor invested in an asset management firm who's taking bets like that, it's hard to do. How are you thinking of that? DYLAN GRICE: Well, we haven't got our asset management business set up yet so it's very easy for me to talk about it before you're actually doing it, but I think what we are in the process of building is a very diversified fund of funds. We will be looking at fundamentally, the best asset classes here. Equity will be a very small slugger there, probably less than 10%. My partner in this is at RannTech, so he will be doing a lot of the quant and helping with some of the credit, but we will also be spending a lot of time on I think more niche areas of credit, more niche areas of the loan market. Some of the different-- the insurance market is-- the insurance market is older than the equity market, phenomenal opportunities in the insurance market, whether it's catastrophe, whether it's longevity, and whether it's mortality or morbidity. There's all sorts of very, very unique return streams that you can pick up with varying degrees of liquidity. In a situation like this, I think the answer is you don't just want to hedge your return profile, you've certainly got genuine correlation. By the way, having like a portfolio of developed market equities and emerging market equities, that's not a diversified portfolio. That's just an equity portfolio. Then if you put 60/40 so you get 40% bonds and you still got basically an equity portfolio. That's no diversification. If you want real, real, real diversification, you have to just move completely away from equities. That's it. That's one of the things we're doing, but the other thing that you have to have diversification of is not just the return stream, it's the liquidity. You can't have-- it depends, if you've got, say, a very-- suppose you're investing in a bunch of different managers who do lots of different things. They're doing quite esoteric things. They need time, you can't just redeem on them and say, I need more money at the end of the month. They need 12 months to get your liquidity back. If all those managers are-- then you've got 12 months, effectively, your fund will be offering 12-month liquidity because the managers that you're invested also often want liquidity. The problem is in a situation like today, there's absolutely nothing you can do. You can't take advantage of any of these dislocations because you have no liquidity in your portfolio. What you want to do, you have to do is diversify your liquidity profile as well. If you've got some uncorrelated assets, can also be very illiquid. Two good examples would be systematic traders, quant traders, transports or mean reversion, wherever they do them, and catastrophe bonds. Catastrophe bonds obviously doesn't correlate with the broader equity market, but you can get rid of these things in a couple of weeks' time. Here are two sources of liquidity, that if they're doing the job properly, and actually catastrophe bonds absolutely have quant doing what they usually do, you would have firepower, you'd have liquidity to allocate to some of these dislocations, whether they were in CLOs or some of the madness gains in unit trusts markets, et cetera, et cetera. It's not just about diversifying your return stream, it's about diversifying your liquidity profile, too. RAOUL PAL: There was one area I still want to talk to you about because I know a lot of the people in Real Vision have looked at it, we've had various people on which is uranium, just love to get your updated thoughts of where we are with that. DYLAN GRICE: We've actually just invested a bit more in that idea. It's something that we came across a few months ago. I'd heard about it, I haven't probably looked at it. I spoke to the guys at Sagra, I spoke to Adam and Arthur and really spent a lot of time with them. They talked me through it, did some reading, and it's just such a no-brainer. Nuclear is a no-brainer to me. I thought that nuclear was, well, I still think that nuclear is a no-brainer. That's the first thing. What does that mean for uranium? I thought uranium was very, very attractive late last year. I think very, very clear deficit in the market. Since then, we've actually seen-- we were seeing already a lot of main shutdowns and mothballing capacity, and we've just seen chemical shots in [indiscernible]. I think we saw another big shutdown as well. I really feel uranium is-- I think this would be more event driven and I would view this more in terms of the optionality. I can look at uranium and see a five to 10 X over the next few years here. I think this is just a great time to be investing in some of these things, again, do you know how to do this? Do you actually know how to value a mining company? Do you know how to value a mining junior or explorer? Either you do it, which is great. You go and do it, or you don't? In which case, find someone who does. Someone somewhere should know what they're doing. RAOUL PAL: Yeah, sure. I was. Recently, I was short the HYG just because I wanted an easy way to-- and then it felt not bad, and I made a bunch of money in it. Then I asked myself, the question is, do I even know what's in it? I'm like, well, at this point, I'll have to leave it to somebody like Dylan who's going to do the homework. That was my macro view, is this is probably going to fall. Now, it starts to give it to somebody who actually going to do the work to know whether I'm stupid by doing this or not. You can take opportunity without being deep by having a view, like you're saying your clear view is nuclear is the answer. Therefore, is there an opportunity to take that bet that's cheap? Which probably is. Then after that becomes complicated is how do you structure a trade like that? DYLAN GRICE: Well, that's right. I think, again, I should say if you don't know how to do that, find someone who does. If you're going to find someone who does, you've also got to know how to spot someone who is legitimate when they say they know what they're doing, versus someone who is not legitimate because nobody-- if you sit in front of a fund manager, you're not going to find a fund manager that says I'm Mr. Average. I don't really know what I'm doing. We don't pay that much attention, frankly, give us your money and we'll put it to work and fingers crossed. You never hear that. Frankly, that would be the correct answer for a lot of them. You have to, yeah, there's no substitute ultimately for doing your homework. If you're going to get-- RAOUL PAL: I do think that it feels to me that the future of this industry is a rejection of asset gathering, and more about specialist expertise. DYLAN GRICE: Yeah, I hope so but I'm not so sure. I'm not so sure. Because I think people have very, very short memories. I really think people do case, people just chase returns ultimately. It's such a strange industry, finance is such a strange industry. If you're making mobile phones, then obviously you want you want customers or prospective customers to look at that mobile phone, and to hold it and to build connection to it and to enjoy the experience of touching it and really feel connected, really, really like this mobile phone. Statically, this is a beautiful thing. That's what mobile phone manufacturers do. That's what car manufacturers do. Fund managers, pretty much everything. If you're an investor, if you've got a portfolio that really looks great, and it's got all the stuff that everyone loves, it's going to be a disaster. The only portfolio that's really going to generate decent returns is going to be one that makes you want to puke. That doesn't sell, that never sells. No one wants to puke when you look at your portfolio. I just think this is a structural quirk of the industry. It's just like-- RAOUL PAL: I can't wait to see how you're going to market this fund. Well, I've got a portfolio. It's going to make you want to feel sick. You're going to call me an idiot but then you're going to give me some money. That's the pit, right? DYLAN GRICE: Yeah, you could be my hand. Thought this through. RAOUL PAL: It's right, you've got some charm. You'll get through. If you use your Scottish accent broad enough, they won't understand a word you're saying if you want it.