The Big Dogs of Physical Commodity Trading

Those of us in managed futures live in a world full of contracts, rules, regulations, and hardly a physical commodity in sight during trades. But there’s an underbelly to all of that activity called physical commodity trading that sometimes gets overlooked by those of us who merely trade the derivatives of all that oil, grains, and what not.

And the physical side of the commodities business is HUGE! We’re talking trillions of dollars huge, and likely among the biggest futures market participants as well. But these names are hardly the household names of other billion dollar businesses like UPS or IBM or the like. These firms largely remain out of the spotlight while they are shipping oil around the world and strip mining the rain forests.

Just who are they? Futures Magazine’s recent piece highlighted the Top 10 physical commodity traders (with an added angle of looking at the trouble they’ve gotten in before). The combined 2012 annual revenue of their Top 10 comes out to be $1.3 Trillion (yes that’s trillion with a capital T), with $60 Billion coming from the tenth ranked physical trader to a whopping $303 Billion stemming from the king of physical commodity trading.

Topping the list is Vitol Group, representing more than a third of the Top Ten’s revenue. They’re the world’s largest physical gas and oil trader. Last year, they sold 2.4 million barrels of Crude Oil. But that’s not all. They also trade sugar, metals, and grains, in large quantities. Just this month, Vitol delivered 144,000 metric tons of Raw Sugar.  Coming in at number two is Glencore International, with revenue of $236 Billion in 2012. The commodity trading giant went public back in May of 2011, with the company’s worth valued at $60 Billion dollars (which is more than Boeing and Ford Motors.) Foreign Policy called them “A Giant among Giants,” after they released private information leading up to their IPO:

The company controlled more than half the international tradable market in zinc and copper and about a third of the world’s seaborne coal; was one of the world’s largest grain exporters, with about 9 percent of the global market; and handled 3 percent of daily global oil consumption for customers ranging from state-owned energy companies in Brazil and India to American multinationals like ExxonMobil and Chevron.

Did they just say half of international tradable zinc and copper?

We are always amazed at the size of the giants of the managed futures industry, like Winton with $25 Billion in assets under management and what we would guess to be annual revenues of $500 to $700 million in a good performance year. But the physical trading firms make even the largest of large CTA’s look like small play things in comparison.

Let’s all hope they stay focused on making billions in their own world instead of coming into the managed futures world to compete… Although with 9 out of the 10 having had some sort of run in with the law, with most paying tens of millions in fines, maybe they would just as soon stay away from being more heavily regulated.

What Everybody Ought to Know About Managed Futures Asset Class Growth

We covered back in November of 2012 how the reported total assets under management in the managed futures industry is a very deceiving number, based on it including the largest hedge fund in the world – $125 Billion + Bridgewater Associates. We found back then that the non-managed futures program Bridgewater represented a full 56% of the assets under management, with the largest actual managed futures program Winton representing another 8%, for a total of 64% of the reported investment in the asset class belonging to just two managers (one of which isn’t a managed futures investment).

Well – when talking about this little discrepancy in a recent conversation, the question was asked:

What does the growth look like without these two behemoths? Is the managed futures asset class even growing without considering Bridgewater and Winton? Great question!

The industry sure likes to tout the tremendous growth of assets under management (see CME here,Open Markets here); but is that growth really across the asset class, or centered on these two marvels of money raising.

It sounded like just the sort of thing we like to dig our hands into… and so we crunched the numbers in the BarclayHedge database to see what the real Ex. Winton/Bridgewater growth has looked like since the end of 2008. What did we find….

• 87% ($102b) of the $125 Billion in new money to managed futures since Dec. ’08 has come from Winton/Bridgewater.
• Just $16 Billion in new money has come into non Winton/Bridgewater managers since Dec. ’08.
• The asset class grew 60% since ’08
• The Ex- Winton/Bridgewater asset class grew just 15% since ’08
• The asset class is down -$3 Billion since June 2012
• The Ex- Winton/Bridgewater asset class is down -$24 Billion since June 2012

Managed Futures Assets Under Management Growth, both with and without Winton & Bridgewater.

(Disclaimer: Past performance is not necessarily indicative to future results)
Source: BarclayHedge Database

Here’s what the quarterly inflows/outflows look like if we remove Winton & Bridghewater, with a current 4 quarter average of a little more than -$5 Billion flowing out of the industry quarterly.

(Disclaimer: Past performance is not necessarily indicative to future results)
Source: BarclayHedge Database

Now, we’re not trying to cause (too much) trouble, but it occurs to us that those building out business plans, getting jobs in the industry, and trying to raise money would be a lot better served to see the real ex-Winton/Bridgewater numbers. We’ve met with more than a few managers who feel they are falling behind in their asset raising, but the reality is they may be doing quite well in light of $5 Billion a quarter currently moving out of managed futures.

As for that quarterly average dipping into negative territory – the contrarian in us loves to see it. We know we’ve been banging the “managed futures is due for a turn drum” for quite some time, but that has all been based on the cyclical nature of trends and those who follow them. The only thing stronger than those cycles, it seems, is investor’s penchant for getting in at the top and out at the bottom… To us, that means good things are coming for managed futures.

What percentage of the futures industry is represented by CTA’s?

We received this question from one of our readers the other day, and it’s a deceivingly simple little question that’s a lot more difficult to answer than you might think.

For starters, do you mean how much AUM does managed futures hold? We peg it at about $205 Billion AUM after removing Bridgewater from Barclayhedge’s numbers. That is a good measure of the assets controlled by CTAs (managed futures managers), but does little to compare to the futures industry as a whole; because managed futures considers the nominal amount of assets (an investor having $500k cash traded as $1 million would be counted as $1 million – the nominal amount), while the rest of the industry is cash based – with measures considering how much in customer assets are held by the FCM’s (futures clearing merchants).

So, while it’s an apples to oranges comparison, we can check out how much customer assets are held across the futures industry by pulling up the CFTC’s financial data for FCMs, and sum the customer required sections to come up with the total customer assets held at FCMs of about $180 Billion. Now, how many such customer assets held by FCMs are in managed futures? Well, if we break down the $205 billion in managed futures by assuming the average cash to nominal level is 3 to 1, we can assume there is $68 Billion in managed futures ‘cash’ held in these FCMs ($205B/3), giving us a managed futures share of futures industry of 37%, if the average leverage used is 2 to 1, it’s a 56% share. If 5 to 1, a 23% share.  The trick is knowing what the average notional funding level is amongst managed futures, but we think it is at least 5 to 1 these days.

Disclaimer: (Past performance is not necessarily indicative of future results)

What about trading volume?

If you aren’t crazy about some of the assumptions made there, what if we look at the amount of trading done versus the amount of assets held? That’s a fun little exercise too:

Again, we start by adjusting the $331.6 Billion in assets reported by BarclayHedge as of the end of thesecond quarter of 2013 (Sol, can’t you just remove Bridgewater so we don’t have to do that math every time we talk about managed futures AUM?), by removing Bridgewater’s $127 Billion in AUM, leaving $205 Billion in assets under management for managed futures.

We’re halfway there, and now need to turn that money under management into the total number of contracts traded annually by CTA’s. Converting AUM to contracts is found with a statistic reported by managed futures advisors called Round Turns per Million. What’s that you ask? A ‘round turn’ is a single completed trade (both a buy and a sell), as opposed to a side which is half of the full trade – either the buy or the sell. Round turns per Million measures how many ‘round turns’ are done per 1 million invested in a managed futures program. Multiply that number by 2 (there’s 2 sides per 1 round turn) and you get the number of contracts traded per million.

Per our experiences in the space, we can tell you the average CTA’s R/Ts per mm is about 1,500. So how many million dollar units are there in the $205 Billion under management? There’s 205,000 units of 1 million, meaning we can multiply that by 1,500 to arrive at 307 Million R/T’s overall per year for the managed futures industry. Convert that to contracts by multiplying by 2 and we get 616 Million contacts.

According to the Futures Industry, there are around 12 billion futures traded annually, and about 12 billion in options, combining to an end number of 24 billion”derivatives” traded globally each year.  So if you divide 616 Million contracts from managed futures by $24 Billion, we get around 2.6% of derivatives. If just on futures, we get 5.2%

If you’re like us and that sounds a little light… let’s dig deeper. From a global scale, it turns out that around 3 billion of the global volume is from Korea (which very few managed futures program access), 2 Billion from the NYSE and Indian stock exchanges, and about 1 billion each from Brazil, Russia, and India’s commodity exchange.  Remove all those totals and we’re left with about 7 Billion contracts regularly traded by managed futures managers. When considering what percent of that 7 Billion, the managed futures volume creeps up towards 9% of futures volume on the leading futures exchanges.

Disclaimer: (Past performance is not necessarily indicative of future results)

Managed Futures: How bad is it?

The main CTA indices are all at 3.5 year lows and sitting on their worst drawdown levels in the past 15 years – at 28 months and -12% from their past all time highs.  And with the year to date numbers negative through August (albeit a small amount),  there’s the very real possibility of managed futures postings its 4^th losing year out of the past 5 in 2013.

What’s more - a comparison of the 10 years prior to 2009 and the March 2009 til now period shows the asset class at levels not seen decades, in terms of the amount and duration of the losses, reminding us of the ‘generational low’ terminology used by the stock folks circa 2009).


            A Generational Low?

(Disclaimer: Past performance is not necessarily indicative of future results)



(Disclaimer: Past performance is not necessarily indicative of future results)

Is it just something weird going on with the indices?  Nope. Check out the performance of 10 of the largest managed futures programs at the end of 2008. Since then, you can see the problem is widespread, with these big programs averaging a current drawdown of -16.95% and 24 months, on average, since their last equity high. 

(Disclaimer: Past performance is not necessarily indicative of future results)

Is Trend Following Dead? (again)

So what’s going on? Is trend following dead?  The short answer is no. The more involved answer can be found in this newsletter, and in a follow up blog post here,  and in a review of 100 years of trend following here.  Both sides of the coin were also argued at length in this LinkedIn Group.

Everyone seems to have a different unscientific explanation for the so called death of trend following, with the following the main arguments supporting why trend following is dead: 

1. There is too much money in trend following now, distorting the trends in the markets.
2. Continuous government intervention in the markets has stymied the development (expansion) of significant trends.
3. Risk on/risk off trading has brought all correlations to one- there is no diversification anymore.
4. Interest rates at 0% have made it too difficult to make money.
5. High frequency trading has destabilized the natural progression of the market cycles.

To tackle these – we’ve seen AQR answer the question of too much money being in trend following with their research showing trend following is at most 0.2% of the size of the underlying equity markets, 3% of the underlying bond markets, 5% of the underlying commodity markets, and 0.2% of the underlying currency markets.  We know from tracking such movements that Risk On/Risk Off is essentially dead.  We’ve seen significant trends in markets like Grains caused by weather, showing the government interventions don’t cap every opportunity, and even seen trends like the move down in the Japanese Yen caused by government intervention.  We’ve covered how the zero bound doesn’t necessarily mean no opportunity in bonds for managed futures.

That leaves HFT and its possible negative effects, which we really don’t know how to gauge or measure. But it seems to us a stretch to think that algorithms getting into and out of the market in milliseconds affect the performance of trend followers holding weeks to months.  HFT could have an effect on execution, but we’re not seeing poor managed futures performance because of slippage – losses are due to trends reversing or failing to emerge all together.

When it comes down to it, trend following at its core is a long volatility strategy which suffers frequent but small losses in exchange for infrequent but large gains.  The strategy attempts to keep its head above water until some market movement provides a large outlier move in which the strategy can profit. To say the periods between these large outlier moves equates to the strategy not working is akin to saying your car isn’t working when going slow in traffic, or that the market will not have outlier moves moving forward (very hard to believe).

But wait…Managed Futures Worst isn’t that Bad

So if trend following (and by extension managed futures) isn’t exactly dead, we can probably agree it’s at least in the hospital getting treatment for being in the worst period it’s ever seen.

Which leads us to the question of how bad is managed futures worst?

if  this is a ‘generational low’ in managed futures; if this is our “2008 crisis”, our 2007 real estate crash, our 1980s -16% loss in bonds? How does it compare with those disastrous periods? We’re glad you asked… because as bad as things are for managed futures right now in their ‘as bad as it’s ever been’ period, the comparison to other assets worst periods is as night and day as it can get.

 
(Disclaimer: Past performance is not necessarily indicative of future results)

 

(Disclaimer: Past performance is not necessarily indicative of future results)
Source: Gold data from USAgold.com; S&P Depression data from MorningStar;
S&P 500 (post depr.) data from Yahoo Finance; Real Estate Data from Case Shiller U.S. National Price Home Index;
Managed Futures data from Newedge, Barclayhedge CTA Index, and Dow Jones Credit Suisse;
Bonds data from Fidelity Invesment Grade Bond 

More of a real world example person? If these were car crashes – the “cars” in the worst periods for stocks and real estate would be totaled after the crash, requiring a full rebuild of the car or off to the scrap yard.  Meanwhile, the “cars” in the worst period for managed futures are seeing a bit of a dent on the bumper, which is unsightly, and a bit of an annoyance – but which is easily repaired.

Other Asset Classes “Crash                                                       Managed Futures “Crash”

Where do managed futures go from here?

We’re starting to see is a shift in attitude from those interested in managed futures exposure  – from invest in managed futures because of the crisis period performance and diversification value, etc. – to… this is a generational buy in managed futures akin to US stocks in 2009. 

The new attitude is buy into managed futures not just because it will help your portfolio when the s^&% hits the fan, but because it isn’t likely to get much worse from here (although it could). It’s now a contrarian, dogs of the Dow, buy the beaten down asset class play.

And here’s the best part – whether you buy managed futures at equity highs or at a ‘generational low’ like we’re in now, the asset class will still provide the crisis period performance and diversification value you’re looking for when the crash comes(assuming you access it via a long volatility crisis period performer, not an option seller or absolute return profile program).

The flows into managed futures do not affect the performance of the asset class like they do in stocks, hedge funds, real estate, and more; meaning the underperformance of managed futures recently has done nothing to injure its ability to perform in the next market crisis (or for that matter – to perform between now and the next crisis).

How do managed futures do it? How do they make sure they are in the next crisis? It isn’t magic, they do it by getting into all the false breakouts which don’t turn into outlier moves. They capture the outliers by exposing themselves to all the normal moves. And that is why there can be losses in between such outliers – they’ve been paying their insurance premium, so to speak, without any events which bring a payout.

So where do we go from here? Well - we’ve been disbelievers in this stock market rally for a while now, so take whatever we say with a grain of salt. But if we ignore the stock market and all the other noise and just focus in on what managed futures itself has been doing, and how people have been feeling about its performance – it seems to us we’re either at, or quickly approaching, the point on the market emotions cycle which represents the ‘Point of Maximum Financial Opportunity’. 

Chart Courtesy: Starlettis of Stock Twits

In the words of Wilson Philips (yes, it is embarrassing to write that line) -  I know there is pain, but Just Hold On, just one more day (week/month/year), things will go your way. 

Largest 2 Year P/E Expansion since late 90s

We have just witnessed the largest two-year expansion of P/E multiples since the late 90’s. This 'bubble' of optimism, sparked by a repressive Fed policy, combined with historical valuation metrics that are above their long-term averages, implies a correction and a period of consolidation is likely to plague the U.S. equity market during the first half of 2014.

Via Barclays,

The improved outlook is fully discounted in share prices... Given that historical valuation metrics are above their long-term averages it is difficult to make a case to the
contrary.

...and the largest two-year expansion of PE multiples since the late 90’s implies a correction and a period of consolidation is likely to plague the U.S. equity market during the first half of 2014.

Research Affiliates:The Impact of Tapering on Risky Assets

The U.S. Federal Reserve surprised the markets by announcing its decision to postpone reducing the purchase of Treasury and agency mortgage-back securities.  The Board of Governors said the central bank will continue buying $45 billion in Treasury bonds and $40 billion in agency MBS every month “until the outlook for the labor market has improved substantially in a context of price stability.”¹ But it is inevitable that the Fed will start winding down its purchase program when labor market conditions improve and inflation expectations are within tolerance.  How will equities and other risky assets be affected?  Understanding the impact of tapering across asset classes and market sectors may enable investors to take advantage of the Fed’s reprieve and position their portfolios advantageously. 

 

In the United States, the prospect of tapering, which is understood as the prelude to eventual tightening, has had the immediate effect of an upward shift in the Treasury yield curve and a bludgeoning of long bonds.²  It has also sent shockwaves to other asset markets; emerging market (EM) bonds, in particular, have declined significantly in sympathy.  It warrants exploring why rising yields on U.S. Treasuries could affect prices of all income oriented instruments so significantly. 

 

Historically, risky assets have exhibited varying degrees of interest rate sensitivity.  Pro-cyclical assets, such as equities, real estate, high yield and emerging market bonds have historically displayed negative correlations with Treasury bonds over annual and longer horizons.  (Table 1.) In normal conditions, interest rates provide information on economic growth.  Rising rates suggest faster GDP growth, better ROIs and a greater demand for investment capital.  These positive factors, in turn, also drive better corporate earnings growth and improve household, corporate and export-oriented EM balance sheets.

 

 

When there is monetary intervention, interest rates also reflect the government’s agenda.  An artificially low nominal interest rate, resulting from quantitative easing (QE), signals a strategy of financial repression against savers in order to subsidize government borrowing and mortgage financing .  As the Fed guides interest rates downward, it also injects an unprecedented amount of positive duration risk into all asset classes.  As a result, pro-cyclical assets, which have historically displayed negative correlation with bond returns, become positively correlated with Treasury returns.

 

Central banks have undertaken multiple QE programs to combat the great recession.  Short-term nominal interest rates have been near zero since the Global Financial Crisis, imposing negative real interest rates—or a wealth tax—on savers.  In this environment, savers seek to escape financial repression by reaching for positive real yield through excess risk taking.  Speculators are subsidized to lever up risky investments; everything with a yield has become a target for the carry trade.  The prolonged period of near zero interest rates has set in motion a substantial flow of investment and speculative funds which has buoyed up prices globally to varying degrees.  (Table 2.) The liquidity driven price appreciation, in turn, injects duration risk.  The greater the liquidity induced appreciation, the more the asset class is exposed to the risk of future interest rate increases.

 

 

When U.S. rates ultimately rise (normalize), it is reasonable to expect some unwinding of the carry trades.  If the 10-year Treasury rate were to hit 5%, then emerging market bonds would lose much of their appeal at their current blended yield of 6%.  This very same dynamic will be in full force for all other asset classes; it has already impacted returns significantly since the tapering announcement in June.  (Table 3.)  U.S. equities, judging from their initial sharp negative response to the tapering announcement, have become bond like!  Bad employment numbers and weak housing starts are now good news for equities as they keep rates low.  High yielding stocks, which have enjoyed significant outperformance in the recent years thanks to their income advantage in a low rate world, appear to be most at risk.

 

 

Nonetheless, eventually prices are set by fundamentals, even if in the short-run liquidity and flows can push prices away from fair valuation.  Ben Graham’s famous analogy captures this combination of long-term and short-term dynamics: the market is ultimately a weighing machine in spite of its more transient role as a voting machine.  Knowing the estimated long-term valuation allows investors to profit from short-term over- and under-adjustments.  As carry strategies are reversed and the ensuing momentum is driven by hot money, rising rates will continue to cause price declines for nearly all asset classes.  This can mean buying opportunities for investors looking to take positions in pro-cyclical risk assets as the U.S. and global economy slowly regain their footings. 

 

In particular, EM equities appear to be the more sensibly priced asset class for accessing global growth.  They are trading at a Shiller cyclically adjusted PE (CAPE) of 13.4x, as compared to U.S. equities trading at a Shiller CAPE of 23.6x.    (Chart 1.)  EM bonds are great values against developed country sovereign bonds at the current spread of approximately 3%.  They are expected to continue receiving more ratings upgrades and fewer downgrades than developed country bonds, and they are backed by stronger sovereign balance sheets and surpluses.  Similarly, high yield bonds at a spread of about 5% are poised to experience yield compression as reflation and mild growth continue. 

 

 

Thus flow induced price declines can be viewed as buying opportunities.  As the carry trade unwinds and the hot money leaves, gone too will be the unnatural positive correlation between Treasury bonds and pro-cyclical assets.  Correlations will return to the norm, and so, too, will the diversification benefits of a globally diversified multi-asset portfolio.

 

 

Endnotes 

 

1 Federal Reserve System press release dated September 18, 2013. http://www.federalreserve.gov/newsevents/press/monetary/20130918a.htm

2 On September 18^th, the day the Fed announced that the purchasing program would continue unabated, the yield of the 10-year Treasury declined from 2.86% to 2.69%.  The 17 basis point change probably reflects the fact that tapering was postponed but not cancelled.

Oaktree group to sell U.S. foreclosed homes

Oaktree Capital Group is leading an effort to put up for sale roughly 500 fully-leased homes, an indication some early investors are looking to cash out on the recovery in U.S. housing prices, according to sources familiar with the market.Oaktree, which manages about $76 billion, and its partner Carrington Mortgage Services are entertaining bids for the portfolio of fully leased homes as they seek to exit from the buy-to-rent trade that has become popular the past two years with hedge funds and private equity firms. The homes, mainly located in several western U.S. states, is being shopped to other large investors in foreclosed homes, said three sources, who asked for anonymity because they were not authorized to discuss the matter. Oaktree, which specializes in distressed investing, and Carrington had initially planned on converting their portfolio into a real estate investment trust. But investors have now decided to simply exit the trade. Their asking price for the portfolio could not be learned. Earlier this year, Reuters first reported that Oaktree, after partnering with Carrington in early 2012, was souring on the buy-to-rent trade after seeing returns on rents from single-family homes begin to compress. Oaktree, which had agreed to spend up to $450 million on building a portfolio, told Carrington this spring that it did not want to continue buying additional foreclosed homes. A year ago, hedge fund Och-Ziff Capital Management put its book of 300 homes in Northern Californiaup for sale — a process it has just about completed. In choosing to sell now, Oaktree and Carrington look to profit from the recovery in home prices. Nationally, the prices for single-family homes are up about 12 percent compared to a year ago, according to the S&P/Case-Shiller composite index. Prices are up more in markets that investors have targeted. In Las Vegas, for instance, homes are selling for 25 percent more than they did a year ago. People familiar with Oaktree and Carrington said the two firms remain interested in working together to invest in non-performing home loans, a business in which Carrington specializes. There has been a transformation in the U.S. buy-to-rent trade over the past year, which initially began with a number of small hedge fund and speculators buying the wreckage of the housing bust in southern California, Florida, Arizona and Nevada. But single-family homes have emerged as new asset class for Wall Street firms. A year ago, private equity firm Blackstone Group and a handful of large Wall Street-backed firms began spending billions in a race to acquire properties in order to get ahead of an escalation in homes prices. Fueled in part by the Federal Reserve's policies, which made it easy to borrow money to buy distressed real estate, the buying spree led investors to become more aggressive in seeking higher-yielding assets. To date, Blackstone is the single largest buyer of foreclosed homes, owning about 32,000 in a dozen states. Other big acquirers are: American Homes for Rent, Colony Capital and Silver Bay Realty Trust Corp. American Homes, Silver Bay and a few other institutional buyers of foreclosed homes have tried to monetize their investment by converting their home portfolios into publicly traded real estate investment trust.

A 30 Minute, Well Produced Video by Ray Dalio on "How the Economic Machine Works"

http://www.youtube.com/watch?v=PHe0bXAIuk0#t=878

Alpha Conference Notes: John Claisse of Albourne America, Joy Xu of Verizon Investment Management and Andrew Karsh of CALPERS

Dynamic Investment Panel: Alpha Hedge West Conference  

MD> Just because you got away with it doesn't mean you didn't take a risk.  Missing 40 worst days more than two times better than getting 40 best days.

JX> Ben Graham said investors need to manage "risk" not "returns".  Risk premium not static.  If you put $1M into market for 20 years each year from '28 to '93, the range of outcomes is between roughly $650K and more than $13M.  Very wide range.  Not losing money is key.  Liquidity is never there when you need it.  Risk premium, not stable, in other words, bonds have frequently outperformed stocks.

AK> $260B in AUM.  Bonds allocated internally.  Real estate and hedge funds managed externally. Goal of 7.5% returns.

JC> Lots of turnover at Board and Trustee level.

SB> Manages about $7B AUM.  Good Harbor Financial.  If they like risk they go equity, don't like risk they go fixed income.  Better to be out of market worst 10 days than in 10 best days.  Is currently 50% stocks and 50% bonds.  Neutral.

JX> They use models or internal management.

AK> Allocates to partners that generates absolute returns vs relative and better dialogue vs normal hedge fund process.

JC> Smaller managers, if they get standard info on active risk taking by global, macro, etc.  They can use that info and insight.

John Burbank & Kyle Bass' Macro Discussion: Alpha Hedge West Conference Notes

KB> First part of taper will be easy.  Fiscal drag of moving Fed Funds from 0% to 3% will be large. 

JB> Does not think Fed policy changes unemployment.  Labor in China first, now technology have a great impact on unemployment.  Firms don't want to hire.  Structural unemployment issues will persist most of our lifetimes.  JB is shifting into equities.  Likes equities with good governance and high quality business.  Not bullish on GDP or global economy or US economy.  Credit got crowded last year.  Equity just getting started.  Companies have gotten very lean and efficient.  Emerging Markets (EM) have been struggling.  That was due.  Development Markets (DM) will outperform EM.  Not that US economy is great, just that US is quality.  As EM people grow, they will want more DM goods, not EM goods.

China

KB> Not investing in China now.  "Univestible" due to banks and shadow banking systems.  Staying away from India too.  Branded luxury and quality did well post crisis.  China has not adjusted from command and control.  Appears Chinal will work, but he think it won't (success is illusory at this point).  Sees restructuring.

JB> His portfolio has turned on its head since 2000 with the exception of internet companies.  Everything in China is rising.  EM and most commodities went up on the industrialization of China.  Won't happen again.  Short the mining companies.  Those businesses have bad economics except when times are really good. Chinese internet companies are winning over US internet companies in China because the Chinese government won't let the Chinese companies lose to US ones.  Internet companies in China at new highs are the ones you probably want to own.  Short EM and Mining.

Why does Bass like Argentina?

KB> People don't understand what is happening there.  Lots of things there are fixable.  Leadership in control has "issues" :).  Energy has been an issue, but recently there have been major energy findings that will change that.  2 years from now, he thinks there will be a new President in October 2015 and pro business people will be running things to take advantage of vast prairies of nature resources.  Argentina's problems can be fixed in 2 years.  Now is the time to start investing.  Sees 50% upside in the sovereign debt.

JB> Would not play Argentina's equities.  Tough betting on turnarounds.  Does not believe in value.  Believes in mispriced growth.  Kyle might be right about Argentina.

KB> "When I'm Right."

Burbank: Long Saudi / Short Russia 

JB> Likes Saudi...though their neighbors are a problem.  He is one of the best informed US investors re: Saudi.  95% of investors in Saudi are local traders. 

Moderator> Is there an opportunity for a paired trade with Saudi?

JB> Short Russia.  Saudi has been crushed.  Instead of easing, they tightened.  They've lagged.  No one wants to invest there.  Aramco would be the largest company in the world by a factor of 10 if it were a public company.  Saudi is like a 1990s EM story in a time capsule.  Dollar rally would crush EM.  Mining gets crushed without rise in commodities.  In '03 and '04 most wouldn't invest in EM.  Now they can't be talked out of investing in EM.  San Francisco is the opposite of EM.  EM has high volumes of low skilled labor.  SF has relatively high concentrations of high skilled labor.  Most people don't understand tech.  Transformational tech requires less capital than ever.  This means lower margins for others.  EM not capable of embracing technology.  SF is impervious to risks like weak GDP, interest rates, etc.  Tech has been camoflauged by rising prices everywhere.  New tech is where you want to be.  Those are "safe" strangely enough.  Investors don't even like to travel to SF.  That will change in the next 3-5 years.

Moderator> Are early stage private companies better investments for tech?

JB>Want to own "Venture Debt".  Low risk.  Even low tech does well.  Innovation premium starting to be revealed.  Want to just be in top 5 or 6 venture funds.  Look for services.  Google is 300B market cap.  Facebook & Twitter.  Not that many tech hedge funds.

Japan

KB> US Recapped.  EU is 3.5x more leveraged than the US.  At some point, debt will matter.  Has always eventually mattered the last 2000 years.  When debts are 24 times revenues you are finished, it is just a matter of when.  Hopes he is wrong.  More he looks, the more he thinks it will happen.  Sees it happening the next few years.  Avoid Europe.  US is 4.5x debts to revs.  Japan is 24.

JB> Dollar is better than Yen or Euro.  Better chance for dollar to rally than market is pricing in.  Chart of S&P to EM tracks closely to dollar chart.  Similar to US in late 90s.  Not because of strength, but due to quanlity and governance in US compared to elsewhere.  Likes Quality in US then betting on low quality of EM.  Believes in multi-year trends until something reaches consensus.  Then you have reversion to mean.

How should mutual funds feel about Macro risks?

KB> If I were long only, I would not be able to sleep at night.  A Japan crisi could not be contained.  It would have huge impacts.

JB> Joke: mutual fund managers happy as long as they beat the benchmark.  This is an era where you want to own the best.  In Silicon Valley it is like winner take all.  Not enough premium on best of breed.

KB> During the Tequilla crisis, Mexican equities down 90%, even with 10x appreciation, you just break even.