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Chapter 6.9: Kyle Bass: The Master of Risk

Chapter 6.9: Kyle Bass: The Master of Risk

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Dallas asking questions.”

Bass lives with his wife and family and serves on the board of trustees of the University of Texas

Investment Management Co., helping to oversee one of the largest public endowments in the country,

with over $26 billion in assets. You’ve already learned about Bass and his nickels: he’s the guy who

taught his children the lesson of asymmetric risk/reward by buying up $2 million worth of nickels and

earning a 25% return on Day One of his investment. In fact, Bass says he’d put his entire net worth in

nickels if he could find that many coins on the market to buy!

Nickels aside, Bass’s relentless focus on asymmetric risk/reward has led to two of the biggest

return bets of the century: in both the housing market and the European debt crisis that began in 2008.

And he’s got a third bet under way that he says is even bigger. What follows is an excerpt of our twoand-a-half-hour conversation in his downtown office.

TR: Tell me a little about yourself.

I was a springboard and platform diver, which people think is intensely physical. But it’s 90%

mental. It’s basically you versus yourself. For me, it was very rewarding. It taught me how to be

disciplined and how to learn from my failures. It’s really how you deal with failure that defines

KB: you as a person. I have a loving mother and a loving father, but they never saved any money. I

swore I would never be like that. My parents both smoked; I swore I would never smoke. For

me, I’ve always been driven harder by the negative things in my life versus the positive—there

are many congruencies in my life and your teachings.

Absolutely. When I look at the one common denominator that makes somebody succeed, beyond


education or talent, it’s hunger.

KB: Hunger and pain.

TR: The hunger comes from the pain. You don’t get really hungry when it’s been easy.

KB: That’s right.

TR: So your hunger drove you to start your own fund. It was 2006, right?

KB: Correct.

TR: The thing that’s so amazing to me is the speed at which you started producing returns.

KB: That was lucky.

TR: You had 20% the first year and, like, 216% the next year, right?

That’s right. It was just fortuitous that early on I saw what was going on in the mortgage market.

I believe in the saying “Luck is where preparation meets opportunity.” I think I might have read

KB: that in one of your books when I was in college. Well, I was prepared. I like to think that I was

lucky and in the right place at the right time because I had all my resources dedicated to that in

the moment.

A lot of people knew about [the housing] problem and didn’t act on it. What was different about


you? What really made you succeed in that area?

If you remember back then, money was basically “free.” In 2005 and 2006, you could get a

LIBOR-plus-250 term loan [meaning, a very cheap loan], and you and I could go buy any

company we wanted with a little bit of equity and a ton of debt. I was on the phone with my

KB: friend and colleague Alan Fournier at the time, and we were trying to figure out how not to lose

betting against housing. And the pundits kept saying, “Housing is a product of job growth and

income growth,” so as long as you had income growth and job growth, home prices would keep

going up. That, of course, was flawed thinking.

TR: Yes, as we all found out.

I had a meeting at the Federal Reserve in September of 2006, and they said, “Look, Kyle, you’re

new to this. You have to realize that income growth drives housing.” And I said, “But wait,

housing has moved in perfect tandem with median income for fifty years. But in the last four

years, housing has gone up 8% a year, and incomes have moved only 1.5%, so we’re five or six

standard deviations24 from the mean.” To bring those relationships back in line again, incomes


would have to go up almost 35%, or housing had to drop 30%. So I called around all the desks

on Wall Street, and I said, “I want to see your model. Show me what happens if home prices

go up only four percent a year, two percent a year, or zero percent.” There wasn’t one

Wall Street firm, not one, in June of 2006 that had a model that contemplated housing

being flat.

TR: Are you serious?

KB: Not one.

TR: These guys just drank their own Kool-Aid.

So in November of 2006, I asked UBS to put forth a model that had flat home prices. And their

model said that losses to the mortgage pool would be 9%. [A mortgage pool is a group of

mortgages with similar maturities and interest rates that were lumped together into a single

package, or security, called a mortgage-backed security. These securities were assigned a high

credit rating and then sold to investors—for an expected return. Assuming house prices

KB: continued to go up, the pool would deliver high returns.] But if home prices didn’t go up, if they

just sat still, these things were going to lose 9%. I called Alan Fournier of Pennant Capital

Management [he formerly worked for David Tepper’s Appaloosa Management], and I said,

“This is it.” And when I formed the general partner of my subprime funds, I named it AF GP—

after Alan Fournier, because of the phone call we had. Because for me, that phone call flipped

the switch.

TR: Wow. And can you tell me what the risk-reward ratio of that bet for you and Alan was?

Basically, I could bet against housing and only pay 3% a year. If I bet a dollar, and home prices


went up, all I could lose was three cents!

TR: Amazing. So the risk—the price to bet against housing—was totally out of whack.

KB: Yep. It only cost me 3%.

TR: Because everyone thought the market would go up forever. And the upside?

KB: If housing stayed flat or went down, I’d make the whole dollar.

TR: So 3% downside if you were wrong, 100% upside if you were right.

Yes. And it’s a good thing I didn’t listen to every mortgage expert I met with. They all said,

“Kyle, you have no idea what you’re talking about. This isn’t your market. This can’t happen.” I

KB: said, “Okay. Well, that’s not a good enough reason for me, because I’ve done a lot of work on

this, and I may not understand everything you understand.” But I could see the forest for the

trees. And the people that live in that market, all they could see were the trees.

TR: You understood the core of risk/reward.

I also heard this a lot: “Well, that can’t happen because the whole financial system would

crash.” That still wasn’t good enough for me either. That bias—the positive bias that we all

KB: have is built in; it’s innate in human nature. You wouldn’t get out of bed if you weren’t positive

about your life, right? It’s a bias we have as humans to be optimistic.

TR: It works for us everywhere but in the financial world.

KB: That’s exactly right.

What’s even more amazing is that after calling the housing bust, you were also right about

TR: Europe and Greece. How did you do that? Again, I’m trying to understand the psychology of

how you think.

In mid-2008, post–Bear Stearns, right before Lehman went bankrupt, we sat in here with my

team and said, “Okay, what’s going on throughout this crisis is that the risk in the world—that

used to be on private balance sheets—is moving to the public balance sheets. So let’s get a

white board and let’s reconstruct the public [government] balance sheets of the nations. Let’s

look at Europe, let’s look at Japan, let’s look at the United States. Let’s look everywhere there’s


a lot of debt, and let’s try to understand.” So I thought, “If I’m Ben Bernanke [head of the Fed at

the time] or Jean-Claude Trichet, president of the European Central Bank, and I want to get my

arms around this problem, what do I do? How do I do it? Well, here’s what I’d do: I’d look at

my own balance-sheet debts as a country. And then I need to know how big my banking system

is in relation to two things: my GDP [gross domestic product], and to my government revenue.”

TR: Makes sense.

So we basically looked at a bunch of different countries and asked, “How big is the banking

system? How many loans are out there?” Then we tried to figure out how many of them were

KB: going to go bad, and then back-solved for how bad it was going to be for us as a country. So I

told my team to go call some firms and find out how big those countries’ banking systems were.

Guess how many firms had a handle on that mid-2008?

TR: How many?

KB: Zero. Not one. And we called everybody.

TR: Wow!

So I dug into the white papers on sovereign [country] debt and read them all. They are mostly

KB: focused on emerging economies, because historically, it was emerging nations that restructured

their sovereign balance sheets.

TR: Developed nations only restructured postwar.

Right. Two countries spend a fortune to go to war; they run up debts, and to the victor go the

KB: spoils and to the loser went defeat, every time. That’s how the world works. In this case, it was

the largest accumulation of debt in peacetime in world history.

TR: Amazing.

So how big is the banking system? We went out there and gathered the data and used two

KB: denominators: GDP and central government tax revenue. And this was a huge learning process

because we had never done it before.

TR: It sounds like nobody else had.

This isn’t rocket science, Tony. This is some idiot in Dallas saying, “How do I get my arms

KB: around the problem?” And so we did the work, and I came up with charts, and I said, “Rank

them worst to best.” Who is the single worst entry on that sheet?

TR: Iceland?

KB: Right, Iceland went first. Who was next? It wasn’t rocket science.

TR: Greece?!

[Kyle nods yes.]

TR: Wow.

So we did all this work, and I looked at the analysis, and I said, “This can’t be right.” I was

KB: being hyperbolic to my team. I was saying, “If this is right, you know what’s going to happen


TR: Correct.

So then I asked, “Where are the insurance contracts trading on Ireland and Greece?” and my

KB: team said, “Greece is eleven basis points.” Eleven basis points! That’s 11/100ths of 1%. And I

said, “Well, we need to go buy a billion of that one.”

TR: Wow, that’s incredible.

KB: Mind you, this is third-quarter 2008.

TR: The writing was on the wall at that stage.

I called Professor Kenneth Rogoff at Harvard University, who didn’t know me from Adam. And

I said, “I’ve spent several months constructing a world balance sheet and trying to understand

KB: this.” I said, “The results of our construct, they’re too negative for me.” I literally said, “I think I

must be misinterpreting these. Could I come sit down and share with you the results of my

work?” and he said, “By all means.”

TR: That’s great.

So I spent two and a half hours with him in February of 2009. And I’ll never forget: he got to the

summary page, with a chart of all the data, and he sat back in his chair, put his glasses up, and

said, “Kyle, I can hardly believe it’s this bad.” And I’m immediately thinking, “Oh shit! All of


my fears are being confirmed by the father of sovereign balance sheet analysis.” So if he wasn’t

thinking about it, do you think Bernanke and Trichet were? No one was thinking about this; there

was no cohesive plan.

TR: None?

KB: He was dealing with curveballs as they were being thrown.

That’s just unbelievable. So I have to ask about Japan, because I know that’s what you’re


focused on now.

Right now, the biggest opportunity in the world is in Japan, and it’s way better than subprime

was. The timing is less certain, but the payoff is multiples of what the subprime market was. I


believe the world’s stress point is Japan. And it’s [about] the cheapest it’s ever been right

now—meaning, [to buy] a kind of insurance policy.

TR: Yes, and what is it costing you?

Well, the two things to take into account for the options pricing model are (1) the risk-free rate

and the (2) volatility of the underlying asset. So imagine if the turkey used this theory. If he were


gauging his risk [of being killed] based upon the historical volatility of his life, it would be zero


TR: Right.

KB: Until Thanksgiving Day.

TR: Until it’s too late.

When you think about Japan, there’s been ten years of suppressed prices and subdued volatility.

The volatility is mid-single digits. It’s as low as any asset class in the world. The risk-free


rate is one-tenth of 1%. So when you ask the price on an option, the formula basically tells you

it should be free.

TR: Right.

So if the Japanese bonds move up 150 basis points to 200 basis points [1.5% to 2%], it’s over.


The whole system detonates, in my opinion.

TR: Wow.

But my theory is, I have always said to our investors, “If it moves two hundred basis points, it’s


going to move fifteen hundred.”

TR: Right.

KB: It’s either going to sit still and do nothing, or it’s going to blow apart.

This all plays into your idea of “tail risk.” Tell me what tail risk is; not many investors focus on



If you look at what I’m doing, I’m spending three or four basis points a year on Japan. That’s

four-hundredths of 1%, okay? If I’m right about the binary nature of the potential outcome of the

situation there, these bonds are going to trade at 20% yields or higher. So I’m paying four-tenths


of 1% for an option that could be worth 2,000%! Tony, there has never been a more missedprice option that’s existed in the world’s history. Now, that’s my opinion. I could be wrong.

So far I am, by the way.

TR: You’re wrong on timing.

I’ll tell you what. I can be wrong for ten years, and if I’m right ten years from now, it was still

100% odds on that to be there before it happened. And people say to me, “How you can bet on

that, because it’s never happened before?” And I say, “Well, how can you be a prudent fiduciary

KB: if I give you the scenario I just laid out, and not do this? Forget whether you think I’m right or

wrong. When I show you the cost, how do you not do that? If your home is in an area that is

prone to fire, and 200 years ago there was a big fire that wiped everything out, how do you not

pay for home owner’s insurance?”

Got it, that’s awesome. So let me ask you this: Do you consider yourself to be a significant risk



KB: No.

TR: I didn’t think so; that’s why I asked. Why do you say you’re not a risk taker?

Let me rephrase that. Significant risk taker means we can lose all of our money. I never set


myself up for the knockout punch.

Tell me this: If you could not pass on any of your money to your children, but you can only pass


on a portfolio and a set of rules, what would that look like for your kids?

I’d give them a couple hundred million dollars’ worth of nickels because then they wouldn’t


have to worry about anything.

They’re done, their investment portfolio is done. Oh my God, that’s wild. What gives you the


most joy in life?

KB: I have my kids.

TR: That’s awesome!

KB: A hundred percent.

TR: Kyle, thank you. I so enjoyed this, and I learned a lot!

24. In finance, standard deviation is applied to the annual rate of return of an investment to measure the investment’s volatility. Standard

deviation is also known as historical volatility and is used by investors as a gauge for the amount of expected volatility.



Director of Marc Faber Limited; Publisher of Gloom, Boom & Doom report

The fact that Marc Faber’s investment newsletter is called the Gloom, Boom & Doom report should

give you a hint about his outlook on markets! But this Swiss billionaire isn’t your average bear. Marc,

who’s been a friend of mine for many years, is a colorful, outspoken contrarian who follows the

advice of the 18th-century investor Baron Rothschild: “The best time to buy is when there’s blood in

the streets.” And like Sir John Templeton, he hunts for bargains that everybody else ignores or

avoids. That’s why, while so many are focused on the US stock market, Marc Faber looks almost

exclusively to Asia for his growth investments. He’s also a blunt critic of all central banks,

particularly the US Federal Reserve, which he blames for destabilizing the world’s economy by

flooding it with trillions of dollars, virtually “printed” out of thin air.

Marc has earned the nickname “Dr. Doom” by continually predicting that the most popular assets

are overpriced and headed for collapse. As the Sunday Times of London wrote, “Marc Faber says the

things nobody wants to hear.” But he’s often been right, especially in 1987, when he made a huge

fortune anticipating the US stock market crash.

Faber’s father was an orthopedic surgeon, and his mother came from a family of Swiss hoteliers.

He earned a PhD in economics at the University of Zurich, and started his financial career with the

global investment firm White Weld & Company. By 1973, he had transferred to Asia, and never

looked back. From his office in Hong Kong and his villa in Chiang Mai, Thailand, Marc has had a

front row seat to the incredible transformation of China from a communist quagmire to the growth

engine that drives the whole region. He’s now considered one of the leading experts in Asian


Marc is known for his eccentricity—he gleefully acknowledges his reputation as a “connoisseur of

the world’s nightlife”—and is a popular speaker at financial forums and on cable news shows. He’s

a member of the prestigious Barron’s Roundtable, where, according to independent observers,

his recommendations have had the highest returns, almost 23% per annum, for 12 years in a

row. Marc is also the author of several books on Asia, and the director of Marc Faber Limited, a

Hong Kong–based advisory and investment fund. Marc speaks English with a gravelly Swiss accent

and never takes himself too seriously. Here’s an excerpt from my onstage interview with him at my

Sun Valley economic conference in 2014.

What would you say are the three biggest investment lies that are still promoted in the world


Well, I think everything is a lie! It’s always very simple! But, I mean, look: I’ve met a lot of

very honest people and so forth, but unfortunately, in your lifetime, you will come across more

salesman-type financial advisors. You should really have people that are very honest. But I can

MF: tell you this from experience: everybody will always sell your dream investments, and my

experience has been, being the chairman of many different investment funds, usually the clients

make very little money. But the managers of the fund and the promoters, they all walk away with

a lot of money. All of them.

TR: Where should investors turn?

There are different theories in the investment world. There are essentially the efficient-market

theory proponents. They say that markets are efficient. In other words, when you invest, the best

is just to buy an index. And the individual selection of securities is basically useless. But I can


tell you, I know many fund managers that have actually significantly outperformed the markets

over time, significantly. I believe that some people have some skills at analyzing companies

because they’re either good accountants or they have skills.

TR: What do you think of the markets these days?

I think there’s still risk in the emerging world, and it’s still too early to buy their currencies and

stocks—and it’s too late to buy the US. I don’t want to buy the S&P index after it reaches 1,800.

I don’t see any value. So best is to go drinking and dancing and do nothing! Do you understand?

It was Jesse Livermore [a famous early-20th-century trader] who said, “The most money made

is by doing nothing, sitting tight.” Sitting tight means you have cash.

In your life, the important thing is not to lose money. If you don’t see really good


opportunities, why take big risks? Some great opportunities will occur every three, four, or five

years, and then you want to have money. There was a huge opportunity in US housing prices at

the end of 2011. Actually, I wrote about this. I went to Atlanta to look at homes, and then

Phoenix. I don’t want to live there, but there was an opportunity. But the opportunity closed very

quickly, and the individuals were at a disadvantage because the hedge funds came in [with cash]

—the private equity guys, they just bought thousands of homes away.


TR: Do you see deflation or inflation coming?

The inflation-deflation debate is misplaced, in my view, in the sense that inflation should be

defined as an increase in the quantity of money. If the money in circulation increases, as a result

credit increases, we have monetary inflation. This is the important point: monetary inflation.

Then we have the symptoms of this monetary inflation, and these symptoms can be very diverse.

It can be an increase in consumer prices, it can be an increase in wages, but again, it’s not as

simple as that because in the US, we have, in many sectors actually, a decline in wages in real

terms over the last 20 or 30 years already, inflation adjusted. But what about the wages in

Vietnam and in China? In China, wages have been going up at the rate of something like 20% or

25% per annum and also elsewhere in emerging economies.

MF: So to answer your question, in a system, we can have deflation in certain things, and assets

and goods and prices and even services and inflation in others. It’s very seldom that in the

world everything will go up in price at the same rate or everything will collapse in price at the

same rate. Usually, if you especially have a fiat currency system, those who can print money,

and what you will have is the money doesn’t really disappear. It just goes into something else.

What can disappear is credit—that’s why you could have an overall price level that would be


But for us investors, we essentially want to know which prices will go up. Like, “Is the price

of oil going to go up or down?” Because if it goes up, then maybe I want to own some oil

shares; and if it goes down, I may want to own something else.

What would you suggest would be the asset allocation to take advantage of in the environment


we’re in right now and to protect yourself?

Well, my asset allocation used to be 25% shares [stocks], 25% gold, 25% cash and bonds, and

25% real estate. Now I have reduced my stock positions as a percentage of the total assets. I


have more cash than I would normally have. I increased the real estate in Vietnam, and I

increased the equity portfolio in Vietnam.

TR: So what might that look like today then, percentage-wise, out of curiosity?

MF: Well, I mean, it’s difficult to tell because it’s so big.

TR: Are you talking about portfolio or something else?

MF: [Laughs.] No, the thing is this: I don’t know! I mean, I’m not counting everything every day.

TR: Well, what would it look like roughly?

Roughly, I think bonds and cash would be now something like 30%, 35%. And then stocks

MF: maybe 20%; then real estate, I don’t know, 30%; and gold 25%. It’s more than 100%, but who

cares? I’m the US Treasury!

We know why you like cash. What about bonds, when many people are afraid they’re at the


lowest level they can be?

The bonds I traditionally hold are emerging-market bonds. The corporate bonds are also mostly

in dollars and euros. But I want to explain this very clearly. These emerging-market bonds have

a very high equity character. If the stock markets go down, the value of these bonds also decline.

Like, in 2008, they tumbled like junk bonds. So they’re more like equities than Treasuries. I own

some of these. That’s why when I say I’ve a low equity exposure of 20%, my equity exposure

through these bonds is probably more than 20%—maybe 30%.

I think sometimes as an investor, we make a mistake that we have too much confidence in our

MF: view, because my view is irrelevant for the whole marketplace, do you understand? The market

will move independently of my view, so I may not be optimistic about Treasuries, but I could

see a condition under which Treasuries would actually be quite a good investment even for a

few years. You will only earn your 2.5% or 3%. But that may be a higher return in a world

where asset prices go down. Do you understand? If the stock market goes down for the next

three years by, say, 5% per annum or 10% per annum, and you have this yield of 2.5% to 3%,

then you’ll be the king.

TR: What about other asset classes?

There’s a lot of speculation for high-end real estate; high-end real estate is at an incredibly

inflated level. I believe all these inflated levels—I’m not saying they can’t go any higher, but I


am suggesting that one day they’ll come down meaningfully. And that in that condition, you want

to have something that is a hedge.

TR: You have a quarter of your assets in gold. Why?

Actually, what is interesting is when I told this to audiences before 2011 [when prices started

dropping], people said, “Marc, if you’re so positive about gold, why would you only have 25%

of your money in gold?” I said, “Well, maybe I’m wrong, and I want to be diversified because

the gold price has already had a big move and is due for consolidation.” Gold is probably to

MF: some extent a hedge, but not a perfect hedge in an asset-deflation scenario if you have it in

physical form. But it’s probably a better investment than a lot of other illiquid assets. It will

probably also go down in price, but less than other stuff. Treasury bonds, for a few years at

least, should do okay in a deflation scenario for asset prices—at least until the government goes


Last question. If you couldn’t pass on money to your kids, only a set of principles to build a


portfolio, what would they be?

I think the most important lesson I would give a child or anyone is: it’s not important what you

buy; it’s the price at which you pay for something. You have to be very careful about buying

things at a high price. Because then they drop, and you’re discouraged. You have to keep cool

and have money when your neighbors and everybody else is depressed. You don’t want to have

money when everybody else has money, because then everybody else also competes for assets,

and they are expensive.

I would also say, look, I personally think we have in general no clue about what will happen

in five or ten minutes’ time, let alone in a year’s time or ten years’ time. We can make certain

MF: assumptions, and sometimes they look fine and sometimes they’re bad and so forth, but we

really don’t know for sure. That’s why as an investor, I would say you should be diversified.

Now, not every investor can do that because some investors, they invest in their own

business. If I have a business like I’m Bill Gates, then I put all my money in Microsoft—and that

was, for a while, at least, a very good investment. Probably for most people, the best is to have

their own business and to invest in something where they have a special edge compared with the

rest of the market; where they have an insider’s knowledge. That’s what I would do. Or give

money to a portfolio manager. If you’re very lucky, he will not lose your money, but you have to

be very lucky.




Founder and Chairman of Charles Schwab Corporation

You’ve seen the ads: a handsome, white-haired man looks directly at you through the camera and

urges you to “own your tomorrow.” Or maybe you remember the ones where cartoon people ask

questions about their investments, and a balloon pops up encouraging them to “Talk to Chuck.”

That’s the style of personal engagement and openness that’s kept Charles Schwab at the

pinnacle of the discount brokerage industry for the past 40 years, and has helped build a

financial empire with $2.38 trillion in client assets under management, 9.3 million brokerage

accounts, 1.4 million corporate retirement plan participants, 956,000 banking accounts, and a network

serving 7,000 registered investment advisors.

Before Chuck Schwab came along, if you wanted to buy some stocks, you had to go through a cartel

of traditional brokers or brokerage firms that charged exorbitant fees for every trade. But in 1975,

when the Securities and Exchange Commission forced the industry to deregulate, Schwab created one

of the first discount brokerages and pioneered a whole new way of doing business that shook Wall

Street to its core. He led an investor revolution, where suddenly individuals could participate fully in

the markets without costly middlemen. While clubby brokerages like Merrill Lynch raised their

trading fees, Charles Schwab slashed—or even eliminated—his fees and offered an array of no-frills

services that put the clients’ interests first and established the model for a new industry. Later he led

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Chapter 6.9: Kyle Bass: The Master of Risk

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