How to introduce Barton Biggs? Why bother, especially to an audience of institutional investors? Traxis Partners, the $2 billion global asset allocation investment group the erstwhile dean of Wall Street market strategists runs with two former Morgan Stanley colleagues, Cyril Moulle-Berteaux and Madhav Dhar, celebrated its first birthday on June 1, having produced a 21.6 percent gain in its first sub-calendar year of operations. This year, they've been "struggling mightily," says Barton, as have most investors, to stay basically flat, but he still evinces confidence that Traxis's yearend results will be reported with a plus sign. What better reason to give Barton a call?
-KMW
Barton, you sounded pretty disgusted about something when you picked up the phone the other day. Hope it wasn't my call.
No. It's just that, obviously, the market isn't as much fun this year. At least, not from the perspective of running a hedge fund. It seemed a lot easier to identify anomalies and to put on successful alpha-creating trades than it is this year.
You wouldn't have it any other way, would you? After all, you could easily hit the beach if you so chose.
Yes. I mean, I must be "mentally challenged" or something. I am definitely not interested in golf and I have climbed all the easy mountains in the world. And, if I try to climb any of the hard ones, I am likely to injure myself – which is no fun, either. So investing is the only game where age doesn't really hurt you.
Frustration seems to be the rule, even – or maybe even especially – among hedgies. How ironic is it that you wrote that very widely distributed piece a year or so ago predicting a bursting of the hedge fund bubble – and now your fund and most of the rest are becalmed, instead?
I continue to be haunted by that particular piece, which I wrote about hedge funds and hedge fund bubbles. In it, I made reference to what I still believe: The hedge fund industry is prone to bubbles in its various sectors. If a sector is hot at the moment, a bubble is quickly created in that sector. But virtually by definition, when a sector gets hot, it is because there are not a lot of people working it and there is a comparatively substantial amount of potential return, or alpha, in it, so the few practitioners generate very high returns. The problem is that those high returns to the few almost immediately attract a big inflow of money into the sector, and the big inflow of money acts as a magnet, pulling a whole new group of practitioners into the sector. We are now witnessing a major evolutionary change.
What makes you say that?
It is a long, complicated story, but the bull market that lasted basically 20 years created immense changes in the investment industry. It generated excessively high fees – because the returns were high, people could charge high fees. Meanwhile, the lucrative levels of profits in the investment management industry generated huge infrastructures in the big investment management firms. Now we are evolving, entering into a period where the returns are going to be probably half or two-thirds, at best, of what they were in the golden era. But the infrastructure is still there. So the big investment management companies have a serious cost problem.
And there's no such thing as job security in Wall Street.
Obviously, they are not dinosaurs but they are going to tend to migrate more towards index or index-plus type products. It's inevitable, I think, that the talent in the business migrates into the hedge fund industry. Yes, there were 1,000 new hedge funds created last year and 1,000 went out of business. The life expectancy of a hedge fund is about the same as an NFL running back, 4.6 years.
Which way is the exit?
My view is that we are going to break out to the upside. I don't think this will be the beginning of a new secular bull market. But I expect pretty significant recoveries in some of the other markets around the world. In that environment, could the S&P 500 go up to 1250 or something like that? I guess it could.
But you're focusing on Europe or Asia, rather than the U.S.?
Well, it sounds crazy but we are focusing on all three regions. But I especially think we're entering what will be a very positive phase for Europe.
Most Europeans dispute that.
I see real signs that Europe is turning and that the socialistic environment that has prevailed there for the last 10 years is coming to an end. Partly because of forces of nature, but also partly because of the addition of these new countries in Eastern Europe to the European Union. It is very important stuff that at French companies, French workers are voting to extend the workweek from 35 hours to 36 hours – without taking additional pay. Across Europe, people are starting to realize that they are going to have to increase the retirement age by five years from whatever it happens to be now.
Even some German unions have agreed to work a little bit longer each week for the same money.
Eventually they are going to go back to a 38- or 40-hour workweek, and they are going to get paid more for that. But the really big story is the savings rate across Europe. Let's take France as an example, where the savings rate is close to 15 percent. Why are the French saving so much? They are saving so much because they are justifiably worried about whether the pensions that they have been promised are going to get paid. But Germany is a classic case. Consider this: House prices in Germany are at the same level they were at 20 years ago.
What does this imply for the dollar versus the Euro?
On a trade-weighted basis, I think the dollar is still about halfway through a secular decline. So the dollar will fall further against the Euro, but but much more gradually than what has occurred in the last 18 months.
If Europe is going to surprise most investors on the upside, is China going to surprise on the downside?
I doubt it, in the short-term. Longer-term, it may be that China is going to have a big bust out there somewhere.
Which I suppose means that the rest of Asia is also in fairly decent shape?
Clearly. We are big believers that some of the most attractive markets in the world are the smaller Asian markets.
The Tigers are coming out of hibernation?
The nations we used to call the Asian Tigers, absolutely. What has happened is that these countries have been through a real depression and deflation since 1997, in a cycle that began with the Thai baht crisis. They have all weathered very serious bear markets in not only their currencies but their stock markets. But the result is that they have implemented real – and necessary – reforms in their banking systems. Now these countries' economies are emerging from those long downturns and they have very, very high savings rates, at low loan to deposit ratios, and very little consumer credit.
What is Thailand's population today?
There are something like 66 million Thais. It is a population growth story. Look, these are economies rising from very, very low bases. They are doing so with cured banking systems that have been partially nationalized. The other big story in Asia is India. But then in the northern part of Asia, there are two cyclical markets – Taiwan and Korea – that just look to us to be unbelievably cheap.
You talk about investing for the long run, Barton. Can your fund actually do that and still show the sort of consistent short-term results that hedge fund investors generally tend to demand?
We do have a one-year lock-up on new money and we try to educate our investors. We try to make sure that our investors understand that we are not a long/short fund shooting for 7 percent, 8 percent, 10 percent annual returns. We are shooting for 15 percent to 20 percent annual returns over a five-year period. The reality is, if you are going to do that, you are going to have an occasional big year and you are going to have an occasional down year. You can also have substantial monthly volatility.
Well, tell me this: How long will your investors have to be patient before your stakes in the Asian Tigers and India for instance, bear fruit? Five years?
Five years is too long. It is more likely to happen over the next 1-3 years. But please, understand where we are invested now. We have substantial net long positions all across non-Japan Asia. In Europe, we have substantial positions, particularly in Germany and in France, principally via the CAC and DAX indices. Our bet is that the emerging markets are going to be the place to be over the next three to five years. They are going to be the techs of the next decade. I also believe that markets like Russia and Brazil have a lot of appeal.
You haven't mentioned the emerging countries of Europe –
We haven't really found much that we want to do there. The valuations are not particularly cheap. They have already gone up a lot. So we are not terribly excited about them.
Yet you find Russia tempting? Despite the Yukos imbroglio?
As of this moment, what is going on is very scary because the government seems to be threatening the property rights of investors. Even though Mikhail Khodorkovsky has basically said he will do whatever he has to do, he will pay the disputed $3.4 billion tax bill and so on, yet the government keeps wanting more. It almost seems like they are determined to re-distribute the wealth to a different class of people – and I don't mean the common people. But I don't believe that it is going to play out that way. I think Russian Prime Minister Putin is too smart for that.
And Brazil?
The Brazilian market is trading at 7-8 times earnings. I have been traveling to Brazil for years. I was just down there recently. I am convinced that the Brazilians are – in their own messy, sloppy way – making progress. In a way, it is a South American India. So its progress is not going to be neat and autocratic, the way China's has been or Singapore's. But progress is happening in Brazil.
So your South American investments are concentrated in Brazil?
Yes. As a macro, top-down hedge fund we spend very little time on individual stocks. So we are not buying individual stocks in Brazil. We buy the Brazilian index. Now, in certain countries like India or Korea, we will concentrate on particular sectors that look very attractive, in addition to the index. We also do that in Japan, in Europe and in the U.S. But in a country like Brazil, we have stuck to investing via the MSCI index.
Putting all this together implies that you must be underweight or even net short the U.S. market?
We are not net short but we are significantly underweight the U.S. in terms of our net long position. Now, we also have various sector longs and sector shorts in the U.S., as well as globally.
What sectors do you think will be better in the U.S.?
But for better or for worse, the sectors that we think are pretty attractive right now in the U.S. are, first of all, the big drug stocks – pharma. Then the food and beverage, tobacco, software, the investment banks and the utilities as well. That's six, actually, that we are net long. On the other side of the ledger, we are short the REITs. We are short the retailers, including Wal-Mart (WMT). We are short the U.S. machinery sector. We are also short energy equipment and services.
When you look at industry weightings in the S&P, aren't the financials an area the contrarian in you would prefer to avoid?
We are in the investment banks and the brokers. In other words, we are in names like, Morgan Stanley, Goldman Sachs, Citicorp, that kind of stuff. Those stocks look very, very cheap. And the four big U.S. investment banks – Merrill Lynch, Morgan, Goldman Sachs and Citicorp – are the class of the world. I don't understand why they have sold off as much as they have.
But your money is on muddling along.
And so far this year, it hasn't produced the sort of results our clients expect. We are down around 3.5 percent. But the year is definitely not over. I think we still have a good chance of having an up year. In the markets and for our investors. I mean, the S&P is down, what, 2 percent here? Ending up in positive territory isn't all that much of a stretch.
Thanks, Barton.
Kathryn M. Welling is the editor and publisher of welling@weeden, an independent research service of Weeden & Co., L.P. Greenwich, Conn. http://welling.weedenco.com
