Monday, June 8, 2015

Against The Gods?

Last Thursday I attended an AIMA luncheon on sources of market volatility and asset class strategies to address them:
The focus of the program is to hear views representing five key drivers of volatility/ liquidity: Geo-political, Central Bank, Banking under new regulations, and both short and long term investors (Money managers, hedge funds, pension funds).

Featured Speakers:

Moderator

Mario Therrien, Senior Vice-President, External Portfolio Management, Public Markets, Caisse de dépôt et placement du Québec

Panelists

Jean-Sébastien Fontaine, Principal Researcher, Financial Markets, Bank of Canada
Marko Papic, Chief Geopolitical Strategist, BCA Research
Greg Tournant, CIO, US Structured Products, Allianz Global Investors
Mihail Garchev, Senior Director, Office of the Chief Investment Officer, PSP Investment
Brian Newcombe, Managing Director, Head of Asset Management & Funding Fixed Income, Currencies, & Commodities, BMO Capital Markets
Claude Perron of Crystalline Management, one of the sponsors and organizer of this event, invited me to attend. I got there just as the luncheon was getting underway (Grand Prix weekend in Montreal meant there was heavy traffic downtown). At my table was Richard Guay, the former head of risk and president of the Caisse who now teaches finance at UQAM, and Pierre Malo, my former boss at PSP who is now consulting at KPMG and "playing lots of golf" (his words, not mine).

Mario Therrien, my former boss at the Caisse who now oversees hedge funds and long only funds, was the moderator and asked each of the panelists to present themselves, "talk about their superpower" (I'm not kidding), and then discuss sources of market volatility and how they're addressing them.

Mihail Garchev who worked with me started things off. He rightly noted his "superpower" is to find bits of information and put it all together to gauge the broader implications for PSP's entire portfolio. In fact, that's exactly what we were doing while working for Pierre at PSP and given his position now working at the Office of the CIO, he's very well placed to give a real bird's eye view of sources of volatility for a large pension fund.

Mihail said there are many sources of market volatility. He differentiated between "endogenous" and "exogenous" sources. The former includes lack of liquidity, company specific news, and different investment horizons among institutional investors like mutual funds, hedge funds, and pension funds. The latter includes anything that isn't driven by markets like geopolitical risks, war, terrorism.

Brian Newcombe of BMO talked a lot about increased regulations at banks and how this is impacting market volatility. He cited specific examples of how increased regulation can imperil the functioning of markets as banks retrench from some trading activities.

Marko Papic of BCA talked about geopolitical risks and stated that Greece doesn't worry him as much as a potential conflict between China and Japan "in the next five years." He rightly noted that most market investors are clueless on geopolitical risks and even said that political science should be part of the CFA curriculum (I personally don't think much about CFAs and not shy to publicly admit it even if some people foolishly think holding a CFA makes them god's gift to finance).

Jean-Sébastien Fontaine provided insights from the Bank of Canada. He noted that external liquidity flows into the Canadian bond and equity markets picked up significantly since 2009. He provided a chart showing how the volatility of bond yields has significantly declined following the release of economic news. There are lots of articles out there about Canada reclaiming haven status among global bond buyers, but I take them with a shaker of salt, just like articles claiming Canada's labor market is at a tipping point. If you buy that, you're in for a rude awakening! (same goes for the latest U.S. jobs data which really don't add up).

Greg Tournant of Allianz asked the audience "who is long vol in this environment?". Most people raised their hand (I didn't). He showed some interesting slides as to why volatility isn't as low as people think from a historical standard and explained why neither being "long vol" or "short vol" is a good strategy. The former one has been bleeding money and the latter one destroyed many investors in 2008. Instead, he likes being long and short vol and has managed to do this successfully, which is no easy feat.

At the end of their presentations, Mario asked them some questions. I paid attention to Mihail's response as I think he touched upon an important segment of dealing with volatility taking what he calls a "holistic approach to risk." He cited examples of how you can deal with volatility in the oil market via your F/X hedging policy and rightly noted that in the future, pensions are going to be asking much more serious questions about the correlations between "infrastructure and real estate" and looking at risks in a very different, holistic way.

I couldn't agree more and think Mihail provided the best food for thought at this luncheon, at least from my perspective. All the presentations were interesting but it takes a real thinker like Mihail to think outside the box and provide unique views on addressing risks pensions are facing (and just like me, he's not a CFA but has more brains than most CFAs I know).

At the end of the luncheon, I commended all the panelists for their presentations but noted that for me, the biggest source of market volatility is the titanic battle of deflation versus inflation that is raging on. There is a reason why yields are at historic lows and why markets are so bloody volatile.

To my surprise, Mario Therrien dismissed my question/ observations stating I was "off topic" but allowed some panelists to comment. Marko Papic said deflation is impossible because it's "politically unpalatable" and Jean-Sébastien Fontaine said that central banks are able to combat and contain the risks of deflation.

A few of the invited guests came to see me or emailed  after to tell me I asked a great question and that Mario was "rude" with his comments. To be fair, I don't think Mario understood my question (either that or he was being an arrogant jerk!) because if he did, he would understand this is far and away the most critical issue of our time as well as the biggest source of market and political volatility.

To Marko Papic, long before you joined BCA Research (where I worked after completing my Masters in Economics), there were guys like Mehran Nakhjavani, George Archer, and Jonathan Nitzan, all of whom understood geopolitics extremely well. Mehran is now working at a competitor, MRB Partners, George is retired but busy on interesting projects outside of finance, and Jonathan is Jonathan, a brilliant professor of political economy at York who along with Shimshon Bichler produces some of the most cutting edge papers on the political economy (read their book, Capital as Power).

I also ran into a few people at this conference which I was glad to see, like Marc-André Soublière who after leaving PSP five years ago went on to become VP of Fixed Income at Air Canada Pension (he's one of the best global macro portfolio managers in the country), Eric Fontaine who left the consulting world to become Senior Director, Policy Portfolio and Asset-Liability Management at PSP Investments (good move on both ends, especially for PSP), and Anny Claude Duval who is the Director,  External Portfolio Management, Public Markets, at the Caisse working for Mario looking at the risks of the portfolio.

Anny Claude was nice enough to come see me after the conference and ask how I was doing. I told her I've been living with multiple sclerosis (MS) for 18 years and even though it has affected me as it has progressed, I'm still very active, write my blog, trade stocks, go to the gym, have an amazing girlfriend and lead a pretty normal life. She told me about a friend of hers that isn't doing well and I referred her to Matt Embry's wonderful site, MS Hope, my blog comment on engineering your alpha, and cited interesting new research on how high dose biotin (vitamin H) may help progressive MS patients.

But I think all of you can learn from Matt Embry's wonderful site, MS Hope, as he explains what being truly healthy is all about and how to best deal with MS. He also shows you why you shouldn't judge people with MS and not hire them because of this disease. Scientists have just found the missing link between brain and immune system, which will have major disease implications for many autoimmune diseases.

Finally, I thank Claude Perron of Crystalline Management for organizing this event. Claude is a true gentleman and I went to their offices after the luncheon to chat with some of the people on their growing team, including Jean-Pierre Langevin and Mathieu Lachance, a former PSP alumnus who is now getting ready to launch their global macro fund (brilliant guy and very nice too, he worked with Marc-André Soublière at PSP). I suggest you contact Claude Perron at Crystalline to get more information on this new global macro fund which will aim to offer great risk-adjusted returns using very little leverage.

As always, I love plugging talent in Montreal but remind all of you, including my friends at Crystalline, that it takes time and effort to write these comments and it's only fair that they and everyone else reading my comments contribute via PayPal at the top right-hand side. There are some very heavy hitters in the pension industry supporting my efforts but it's fair to say that I'm grossly underpaid for this work.

Speaking of work, I'm always open to new challenges and will gladly welcome any new opportunities you have for me. My CV? Pension Pulse. My contacts? Pretty much the who's who of Canadian and U.S. pensions. They don't all love me, but I guarantee you they'll all meet me and take my phone call (except maybe for the guy out in Victoria, he's too busy or riddled with guilt to take my call, but even he will one day realize his huge monumental mistake and come to terms with demons of his past).

Below,  Peter Bernstein, celebrated author of Against the Gods: The Remarkable Story of Risk explores the history of risk and how it works in real-world markets and in our lives. Great book which everyone should read. Click here to see this interview.

Also, Brian Reynolds, New Albion Partners, forecasts the credit market and predicts years ahead for a bullish market. Very interesting interview which discusses why we're in the midst of the greatest credit boom ever but the increase in systemic risk will lead to a bigger crisis in a few years.

I don't know about that but agree with my friend Brian Romanchuk, last week's bond market volatility is a yawn and too many people are getting flustered over a possible (but unlikely) Fed rate hike this year.

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