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Episode: Eric Peters - Paradigm Shifts and Solutions at One River (EP.422)

Author: Ted Seides – Allocator and Asset Management Expert
Duration: 00:39:41

Episode Shownotes

Eric Peters leads both One River Asset Management and Coinbase Asset Management and writes a widely dispersed blog called Wknd Notes, in which he shares macro insights. He’s twice been a guest on the show, discussing his bespoke macro investment strategy four years ago and the case for Bitcoin three

years ago. Both conversations are replayed in the feed. Since then, many of One River’s strategies played out well during Covid, and Coinbase acquired One River Digital Asset Management in March 2023. We got back together to discuss how Eric has adapted to the changing environment, including One River’s shift from bespoke offerings to a total portfolio solution and the continued case for Bitcoin. Along the way, Eric shares his keen insights on portfolio construction, left-tail risks, and right-tail opportunities. Take Capital Allocators Audience Engagement Survey Learn More Follow Ted on Twitter at @tseides or LinkedIn Subscribe to the mailing list Access Transcript with Premium Membership

Full Transcript

00:00:01 Speaker_02
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00:02:18 Speaker_02
Learn more at SRSAquium.com. That's S-R-S-A-C-Q-U-I-O-M.com. Hello, I'm Ted Seides, and this is Capital Allocators. This show is an open exploration of the people and process behind capital allocation.

00:02:43 Speaker_02
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00:02:59 Speaker_00
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00:03:06 Speaker_00
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00:03:19 Speaker_02
My guest on today's show is Eric Peters, who leads both OneRiver Asset Management and Coinbase Asset Management, and writes a widely dispersed blog called Weekend Notes, in which he shares macro insights.

00:03:33 Speaker_02
Eric's twice been a guest on the show, discussing his bespoke macro investment strategy four years ago, and case for Bitcoin three years ago. Both conversations are replayed in the feed.

00:03:45 Speaker_02
Since then, many of OneRiver's strategies played out well during COVID, and Coinbase acquired OneRiver Digital Asset Management in March 2023.

00:03:54 Speaker_02
We got back together to discuss how Eric has adapted to the changing environment, including OneRiver's shift from bespoke offerings to a total portfolio solution and the continued case for Bitcoin.

00:04:08 Speaker_02
Along the way, Eric shares his keen insights on portfolio construction, left-tail risks, and right-tail opportunities.

00:04:18 Speaker_02
Before we get going, I was walking down the street and saw my friend Brian Furtado, the head of the family office practice at Apollo, on the other side of the street with a handful of shopping bags. Brian is a very affable, can-do type of guy.

00:04:34 Speaker_02
So as I crossed the street to say hello, I was surprised when he appeared frazzled and mumbling to himself. He looked up at me and repeated a phrase twice. Just keep buying. Just keep buying.

00:04:48 Speaker_02
since that December 23rd three years ago, just keep buying has become a mantra in our house during moments of holiday-induced stress. It's not really about retail therapy, although my wife Vanessa might mean it literally from time to time.

00:05:03 Speaker_02
It's about remembering that the sprint to the holidays can bring some stress, but the actions we take spread joy and cheer when the big day comes.

00:05:12 Speaker_02
So whether you're celebrating Christmas, the first day of Hanukkah, or anything else on December 25th, when you feel the inevitable pressure of the holidays, take a small action with the gift of giving in mind. Just keep buying.

00:05:26 Speaker_02
Thanks for spreading the holiday cheer with Capital Allocators. Please enjoy my conversation with Eric Peters. Eric, great to see you. Great to be back. Well, in the last couple of years, there's a lot that's changed in this entire environment.

00:05:43 Speaker_02
And I'd love to start with how have you structurally addressed the changing environment?

00:05:49 Speaker_01
boy, our business has gone through a lot of change. 2020 is the place to start. Prior to 2020, we were in this world of perceived secular stagnation, and something was going to come along to propel us out of that. That was the rise of talk about MMT.

00:06:04 Speaker_01
And it made sense that whenever the next crisis hit, we would see a much different policy response from what we've seen in prior cycles, and then COVID hit. So prior to 2020, we had thought that inflation was going to pick up.

00:06:17 Speaker_01
I felt like we had the right strategy lineup for our clients. So we had trend following, we had long volatility, we had inflation strategy that we're trying to get off the ground.

00:06:28 Speaker_01
We felt pretty well positioned for that going into, for what we thought the next cycle would look like. And then that cycle hit, which was an incredible catalyst relative to anything I could have imagined, but all those themes started to play out.

00:06:40 Speaker_01
big fiscal deficits, monetary debasement, inflation, and that provoked all sorts of changes in how we thought about our business and our solutions. So that was really the kickoff. What were some of those changes?

00:06:52 Speaker_01
For starters, we thankfully got through COVID with having delivered what we said we would deliver. So our long fall made a lot of money and we had weekly liquidity for our clients.

00:07:00 Speaker_01
We had huge redemptions through that, which is exciting because you want to deliver for your clients and you want to think that you can deliver weekly liquidity, but then you also have to have service providers strike a nav on every Friday in March and April.

00:07:11 Speaker_01
So the first part of it was that what we were doing worked. Then the question was, so what really happens from here?

00:07:18 Speaker_01
Because the catalyst for this new investment paradigm that we thought we had entered was so powerful that we thought correlations are going to be changed for a long period of time.

00:07:28 Speaker_01
So like the equity bond correlation could change, and that changes every institutional portfolio in terms of how it's going to perform, how to think about risk, where to seek opportunities.

00:07:36 Speaker_01
So we put a lot of thought into how do we help our clients more with what we have. And then we also entered crypto in November of 2020.

00:07:44 Speaker_01
And that was really to express one of those themes, which was monetary debasement and also captured some of the convexity of this new technology that was poorly understood at that time. What does OneRiver look like today?

00:07:56 Speaker_01
I am so excited about what we have going on right now. Wind River is about $3 billion business, and it's primarily focused on risk mitigation strategies. For the most part, our assets are in trend following and volatility strategies.

00:08:08 Speaker_01
We have a dispersion strategy as well, but the bulk of our assets are in systematic long equity vol and combinations of systematic long equity vol paired with trend following.

00:08:18 Speaker_01
our total portfolio combined systematic long equity vol with trend following combined with equity beta.

00:08:24 Speaker_01
So I took the position when we started OneRiver, let's build a suite of different strategies that our clients can use either on a one-off basis or in combination to help tilt their portfolio, complete it, build various solutions that help their needs.

00:08:37 Speaker_01
And that's how we got to $3 billion. What we've never done is launch a flagship strategy.

00:08:41 Speaker_01
So a year and a quarter ago, I'd put the challenge out to the team, what do we have and what can we do that we think and that I would put all of my liquid capital into? If you could only do one thing, what would that be?

00:08:54 Speaker_01
And we did a lot of work around how to combine our strategies with equity beta. And that kicked off a series of three white papers that we published, which in combination are the underpinning for this total portfolio.

00:09:07 Speaker_01
The result of it is if you combine equity beta in a leveraged way, like a portal alpha type return stacking way, with what we do at this firm, our strategies are negatively correlated, positively convex. So anytime there's a wobble in the market,

00:09:23 Speaker_01
What we do should make somewhere between okay money and really good money at a time when the S&P is drawing down, and then you can rebalance those positions, which allows you to start compounding from a higher baseline.

00:09:35 Speaker_01
So the compounding effects are massive. So that's really one river. This will be the most important thing I do in my career from an investing standpoint. In terms of our contribution to investing, this is what our firm will in time be known for.

00:09:48 Speaker_02
You mentioned you wanted something where you'd put all your money in. How do you think about, what are you trying to accomplish with the strategy?

00:09:54 Speaker_01
Trying to accomplish compounding at the highest possible rate with drawdowns that are sufficiently manageable that you won't lose your nerve. That's important for any investor and we all have different pain thresholds.

00:10:04 Speaker_01
Mine happens to be high, by the way, but I wanted to build a strategy that was tempered. So ideally, the way we looked at it and the challenge that I had was, can we compound it higher than the S&P with lower drawdowns and a better Sharpe?

00:10:17 Speaker_01
And when I say mitigating the downside so that you don't lose your nerve, what I mean by that is everyone wants to outperform the S&P, the entire world. And if there are aliens, they probably want to outperform the S&P.

00:10:30 Speaker_01
The question is, what are you going to do in order to do that? And there are all sorts of portfolio combinations where people try to do various things.

00:10:37 Speaker_01
Some of them try to outperform the S&P and they end up oftentimes taking on a lot of additional risk. that's quite correlated to underlying equities and it works great in the right market environment.

00:10:48 Speaker_01
And then when the market turns against those players, the losses that they suffer are such that they end up getting out at the worst possible time.

00:10:55 Speaker_01
They're either forced out or they choose to get out or their investment board says, why are we taking these risks? We didn't really understand it. So, it's super important that whatever you build can survive adverse market environments.

00:11:07 Speaker_01
And what I tell the team all the time here, nothing good happens to dead people. It just doesn't. So, the first and foremost, you have to figure out whatever you're doing, how do you make sure you survive it?

00:11:16 Speaker_01
That's really the objective because by the way, I don't know what equities are going to return on a forward-looking basis. I suspect that it won't be as strong as looking back over the last 20 years. I suspect it'll be more volatile.

00:11:27 Speaker_01
There could be times where it's brilliantly positive as well. I think there are big right tails. There are also some really bad tails that are potentially out there.

00:11:35 Speaker_01
So I just wanted to make sure that we had something that was robust to any range of market environments that you wouldn't get squeezed out of the position and that could ideally compound better than equity and be liquid

00:11:46 Speaker_02
When you start looking at the pieces that brought this together, you mentioned the S&P as the equity beta. How do you think about the S&P versus some other form of equity beta as the driver of that growth engine?

00:11:57 Speaker_01
This strategy has three different equity betas for people. So one is the S&P 500, another is the NASDAQ 100, and then MSCI World. That covers most of it.

00:12:06 Speaker_01
What I wanted to see when we did our analysis, this framework, what would it look like if we had some really lousy equity beta in there instead? we try to find the worst stock markets in the world that are credible stock markets.

00:12:17 Speaker_01
Eurostox 50 and Hang Seng, those are the two really worst stock markets in the world from a performance standpoint over the last 17, 20 years.

00:12:26 Speaker_01
And if you create this portfolio combination with the rebalancing structure that we have put in place, you achieve multiple times, even with a lousy underlying equity market.

00:12:37 Speaker_01
If you really want to be an investor and make money, you got to invest in equity. You got to invest in the underlying growth of the economy. So I don't know what the future holds in terms of what our equity is going to deliver.

00:12:46 Speaker_01
Hopefully a lot in real terms, probably quite a bit in nominal terms, given what I think will happen. but I don't really know. The key is to have that construct that you think will outperform.

00:12:58 Speaker_02
So, we'll get into the more interesting stuff on top of it. You mentioned that you're putting systematic strategies and not discretionary. In the past, you've done both. Why did you come to wanting to do this with systematic strategies?

00:13:09 Speaker_01
I've been a discretionary trader investor my whole career. And when I launched OneRiver in 2013, I tried to think of things in 10-year increments. So I really thought about what I wanted to build.

00:13:20 Speaker_01
What I concluded was that if we didn't embed technology within our firm, we would be unlikely to have a firm in five or 10 years. That was a pretty simple statement, high conviction.

00:13:31 Speaker_01
Just because if you look at technology trends in every aspect of society, you want to be long innovation. And I thought without that, then I don't know, maybe I'm just reminiscence of the stock operator.

00:13:42 Speaker_01
Nothing's really changed for how discretionary investment decisions are being made.

00:13:46 Speaker_01
The upside is as a discretionary investor, you can potentially see things around the corner that have never happened before, haven't happened in such a long period of time that your quantitative strategies can't foresee it. So that's the advantage.

00:13:58 Speaker_01
The downside is you have a human making decisions and you have a lot of emotion involved.

00:14:01 Speaker_01
So I thought that if we could embed discretionary investing principles that I and the team have learned over time into strategies that are fully codified, and we could take out the emotion from investing,

00:14:15 Speaker_01
build really well risk-managed quantitative strategies so that if we were wrong and there was something that had never happened before, we have something to get us out. But that was the bet that I made in 2013 with the firm.

00:14:27 Speaker_01
And as it turns out, the vast majority of our assets under management are in quantitative strategies that

00:14:33 Speaker_01
One of the advantages you have there is if you come up with the right investing principles, you can apply them across a lot of different markets and typically do them in instruments that are quite cash efficient.

00:14:42 Speaker_01
So they're pretty scalable and they combine well into solutions for our clients. And the other advantage of quant strategies is that when you sit across the table from a very large allocator, who's comfortable with quantitative strategies.

00:14:56 Speaker_01
So you can look at how the logic embedded within that strategy would have done in a variety of different periods without having to guess what someone's discretionary decision would be.

00:15:07 Speaker_01
And I think that's actually really valuable, particularly as you combine strategies. So I've gravitated very strongly in that direction. There will always be things that one river does on a discretionary basis.

00:15:18 Speaker_01
Moving to crypto was incredibly profitable and that was discretionary and it was working with one of our biggest clients who's a brilliant investor. And we'll do things like that in the future, but there'll be fewer and further between, I think.

00:15:30 Speaker_02
So within the strategy, there's the long vol piece and there's the trend piece. On the long vol component, what are you putting into this new aggregated strategy?

00:15:40 Speaker_01
So the long fall component we've been running since 2015, it's called Dynamic Convexity, and it's well-named in the sense that it's a highly convex strategy.

00:15:49 Speaker_01
It trades in VIX futures, options on VIX futures, VSTOX futures, which is the VIX equivalent in Europe, and a whole host of different straddles on global equity indices.

00:16:00 Speaker_01
So there are a number of legs to the stool, so to say, and we continue to do research and put new interesting things in there. And it's very capital efficient, which is why we can build it into this total portfolio.

00:16:14 Speaker_01
When we combine our dynamic convexity and our trend following strategies into one strategy, it's called risk responders. We use roughly speaking in a benign market, 23% of the cash for margin and in a stressed environment that might go up to 50.

00:16:30 Speaker_01
So, we have all this extra cash, which allows us to marry that with equity beta using futures, so that we have in the total portfolio in a normal market environment, $0.31 of every dollar is invested in futures. The rest is in cash earning T-bills.

00:16:45 Speaker_01
Having those components that are really capital efficient, they work well together.

00:16:49 Speaker_02
What is it that makes it more capital efficient than another comparable strategy?

00:16:53 Speaker_01
There are all sorts of different strategies that people use to try to attempt to be long-fall. We have a very purist approach. And when I'm purist, I mean, we only ever are long-fall. We never are short-fall.

00:17:05 Speaker_01
And the reason for that is over my career, which is now 35 years,

00:17:10 Speaker_01
At every cycle, I have seen people who have convinced themselves they're long fall on a net basis because they're long fall somewhere and they're short a little bit somewhere else because they don't think it's really going to hurt them.

00:17:21 Speaker_01
And then there's some unique aspect to this latest crisis, and then they either don't perform or they really underperform, or in some cases, they lose everything.

00:17:30 Speaker_01
So, we come at it with the appropriate amount of humility, which is to say, look, we understand these markets really well, but we don't know what the future holds. So, we're not going to be shortfall anywhere. In our case, not much is going on.

00:17:42 Speaker_01
We have extremely low capital usage. We could have as little as 5% of capital that we're using in a really quiet market, but it's very dynamic. So, that can ramp up in a crisis like COVID, it could ramp up to 30, 40, 45%.

00:17:57 Speaker_01
When you think about combining solutions like this into something like total portfolio, cash efficiency is vital. Without it, you can't do it.

00:18:05 Speaker_02
When you've traded across all different markets, why do you choose equities and not some mix of all different assets?

00:18:12 Speaker_01
The real use for dynamic convexity is to help our clients reliably lean something up against the biggest risk in their book. We work with pensions, endowments, sovereigns.

00:18:24 Speaker_01
If you look at the real risk in their portfolio, it's probably 90% driven by equities, and it comes in all sorts of different forms, private equity, public equity, credit.

00:18:32 Speaker_01
You end up with portfolios that there's just one risk factor, which is equities. So having a strategy that was highly convex to let's say a move in oil or gold or something like that, it might work for those investors, but it might not work at all.

00:18:46 Speaker_01
So that's biggest reason, but there are also liquidity reasons. The VIX market is an incredibly deep liquid market. So we can move through that market without having a footprint and that's a great thing.

00:18:58 Speaker_01
In this risk responder strategy, which trend strategies are you pairing with the long equity vol? We run two trend strategies. One is on what we call core markets and the classic funds.

00:19:10 Speaker_01
We also offer an alternative market trend strategy, which is 110 markets. There's a little bit of overlap. Roughly speaking, I think we have 153 markets, 154 markets that we trade across those trend following strategies.

00:19:26 Speaker_01
We've tried to find markets that are as lowly correlated as possible.

00:19:30 Speaker_02
How do these three components, the equity beta, long vol, and trend work together such that you took equity beta and as you looked at it historically, this outperforms?

00:19:40 Speaker_01
What we do is we take, say, $100 of equities, we replace that with futures contract, and we actually put in $110 of equity exposure. Explain that in a second. So that probably takes $7 of margin to do that. So now we've got 93 bucks left.

00:19:55 Speaker_01
And then we layer in the risk responders program, which is $23 out of every hundred. And we put 100% of that risk responders, which is dynamic convexity and trend falling in there.

00:20:05 Speaker_01
In a benign market, we call benign market that's drifting or trending upwards. We're going to expect in dynamic convexity to lose 2% to 5% a year. So having 110% equity beta.

00:20:15 Speaker_01
basically just looks at that strategy and says, well, if the market drifts up, there's going to be some drag because you're long this dynamic convexity, you're longer hedge essentially, and that hedge is going to cost you.

00:20:26 Speaker_01
So if you combine those two things, you should still end up with 100% of the equity performance on the upside.

00:20:32 Speaker_01
And then you look at trend following and you go, okay, over the long haul, let's say trend is going to deliver a plus 0.2345 sharp, something like that. But for the purposes of this portfolio construction, just imagine it does nothing in a year.

00:20:45 Speaker_01
So now what happens in a strong S&P year? Well, your S&P goes up, let's say 15%. You invested $100, it's now worth 115. What you can do is take your risk responders portfolio and just size it up to that new overall 115 level.

00:21:01 Speaker_01
So now you start compounding again off of the 115 base. But you've got more protection on because you've been able to upsize it because the whole portfolio is a derivative portfolio.

00:21:11 Speaker_01
Now imagine that next year, the S&P is down 20% or you have a COVID or you have a GFC. Well, you are highly likely to make a lot of money in your risk responders program. and your S&P is going to be 20% or 30% or 40% down.

00:21:29 Speaker_01
So now what you're doing is you're looking at that overall portfolio level. It's going to actually be higher than 115, even though equities are deeply discounted, but you're rotating money back into the S&P.

00:21:40 Speaker_01
When that market correction or bear market ends, you're now compounding from a much higher base than if you just owned equities the whole time. How do you think about the optimal rebalancing strategy?

00:21:51 Speaker_01
The team did a lot of work on this and they looked at countless simulations of different rebalancing schedules and they looked at calendar-based reschedules, they looked at threshold-based.

00:22:02 Speaker_01
So if my hedge is up 10% or 50 or 30 or whatever it might be, we rebalance half of it or all of it because that's often what investors do. The conclusion from that was actually the optimal approach is pretty simple actually.

00:22:17 Speaker_01
Somewhere around a month is a pretty good place to be. If you choose thresholds, sometimes if you choose the exact right threshold, it's great because there's no give back.

00:22:27 Speaker_01
But if risk response is only up 27% or 29% and you didn't at that threshold and it came back against you, you'd have a poor outcome. So what you find is there's a lot of variance in the threshold-based.

00:22:37 Speaker_01
Now, what was funny is we were in Australia speaking with a big client and we said, well, here's the work. So what do you think? And they're like, we're definitely going to continue to do threshold. And we're like, Why?

00:22:49 Speaker_01
That's fine, but the research says otherwise. They're like, because there's the investment board effect.

00:22:53 Speaker_01
If our portfolio is under a ton of stress and we have some type of hedge that's up 30 or 40 or 50% and we walk into the boardroom, they're going to say, take it off.

00:23:01 Speaker_01
So we ran simulations looking at combinations of threshold-based and calendar-based, and those are really quite good as well.

00:23:08 Speaker_02
Does that calendar rebalancing over threshold rebalancing have a similar analysis if you looked at an allocator multi-asset class rebalancing?

00:23:17 Speaker_01
That's a good question. I'll bet you it does. Even when we know we're going to make stupid decisions, sometimes we just can't help ourselves. So we could look at all the data and say threshold is inferior statistically

00:23:29 Speaker_01
and the probability of really getting it wrong is much higher, but people are still gonna do it. I completely understand why, but if you have, in a way, if you can make the choice to do it in a dispassionate way, over time, you're gonna do better.

00:23:42 Speaker_01
When does the package suffer the most? The package suffers the most when trend is underperforming and vol doesn't really kick in and equity markets are performing poorly.

00:23:55 Speaker_01
Because if equity markets are performing well, then you could say, well, we're underperforming S&P. Okay, we have a strategy that should outperform the S&P substantially through time, but that doesn't mean it always will.

00:24:07 Speaker_01
So I don't view that as being a real negative. So the question is, can you have a period where the S&P goes down, trend following doesn't really make money, and you don't have a really convex type panic, where dynamic convexity kicks off.

00:24:23 Speaker_01
The key, you asked earlier, what is it built for? It's built so that you don't ever have to panic out. So I'll take half the drawdown on the S&P 500. If you're going to make money, you've got to take risk.

00:24:32 Speaker_01
It's a little bit higher vol than the S&P 500, which I think is good because it has lower drawdowns, better sharps. So I'd like that vol.

00:24:38 Speaker_02
All right, let's pivot to crypto. When you last came on, we were talking about crypto. You had just done this big trade. Nothing happened, and then a lot's happened of late.

00:24:47 Speaker_02
Why don't you talk about your trajectory of that initial focus on trading this big Bitcoin trade to where you are today?

00:24:55 Speaker_01
That was just an insane period. We all have our war stories. Since we talked so much has happened in the crypto industry, it felt like the US was behind crypto at the time, the rest of the world was against it.

00:25:06 Speaker_01
And then, wow, the Biden administration came in and I don't know why a technology ever got politicized, but it did. And then we had a big rate hike cycle and crypto fell apart. And then we had Sam Bankman freed and we thankfully dodged the bad actors.

00:25:20 Speaker_01
We had an incredible advisory council, Jay Clayton, and then Kevin Hassett, who just joined the Trump administration. They were super helpful in terms of giving us the type of perspective around what was likely to unfold from a regulatory standpoint.

00:25:31 Speaker_01
We started building a platform, which is going to be infrastructure for tokenizing essentially all traditional assets. as opposed to tokens like Bitcoin or Ethereum.

00:25:40 Speaker_01
So taking real world assets or traditional stocks and bonds and all sorts of loans and someday almost anything you could imagine, tokenizing them. We built out a crypto asset manager.

00:25:51 Speaker_01
Coinbase acquired that about a year and a half ago, which I saw that as a once in a lifetime opportunity. So I actually run two firms right now. So I'm the opposite of bored.

00:26:02 Speaker_01
It seemed like an incredible opportunity to have this absolute leader in this brand new technology that I think will reshape finance and probably to a degree reshape the world in all sorts of unique ways.

00:26:15 Speaker_01
You had the 800-pound gorilla, which is Coinbase, that didn't have asset management and they wanted that. And we had an amazing relationship with them. And the people there are phenomenal.

00:26:24 Speaker_01
Brian Armstrong as a CEO is like being part of a founder, CEO-led firm is the place to be. So that all happened to us in crypto or that all unfolded since you and I last chatted. So now we got two jobs.

00:26:37 Speaker_02
So a couple of years ago when we were talking, you were pretty focused on Bitcoin in the ecosystem. How have you thought about Bitcoin versus everything else happening in crypto?

00:26:47 Speaker_01
There's always talk about, well, how dominant is Bitcoin relative to the other coins? And right now it's around 60-ish percent of the overall market.

00:26:56 Speaker_01
And there tends to be this cycle where in really big spec cycles, a lot of the lesser known coins get a big following and their value goes up and the dominance of Bitcoin relative to the whole ecosystem declines.

00:27:08 Speaker_01
And my view has been that there are all sorts of reasons to be bullish on Bitcoin. I think Bitcoin is this really unique store of value.

00:27:16 Speaker_01
It's an asset unlike any other asset that I am aware of in the history of the world in the sense that no matter what the price is, the supply will not respond. It has a predefined schedule of supply over the next 100 years or whatever, 120 years.

00:27:32 Speaker_01
So no matter what the price is, there's no supply response. Everything else in the world everything, a condo, gold in the ground, oil, television set, housing, everything. If the price goes up, people figure out how to make more of it.

00:27:45 Speaker_01
They can't make more of Bitcoin. So it has this unique store of value feature to it, but I also think it's the most secure network ever created by human beings. So we don't yet know what humans will find to attach to that secure network.

00:27:58 Speaker_01
It's still early. And I think to bet that humans won't figure out how to use that security network for something in addition to store of value is to be betting against human innovation, which I would never do.

00:28:10 Speaker_01
So Bitcoin has this great store of value feature to it that was underappreciated four years ago. It's better appreciated now that BlackRock's in the game, but it's still underappreciated relative to where it will be in the future, I think.

00:28:22 Speaker_01
And it has this other tech call option feature to it, which people value at almost nothing. I value it at a lot. Then there are all these other coins as well. So Ethereum financial markets and infrastructure will be built on Ethereum.

00:28:35 Speaker_01
Maybe parts of it will be built on Solana too. I'm not sure. So I've been biased toward Bitcoin and I think that's been the right thing to be.

00:28:42 Speaker_01
But I think we're now at a stage with this election where the US has gone from being this massive headwind to the adoption of this technology to what's about to happen is we're about to feel a tailwind.

00:28:53 Speaker_01
And that is super exciting because this is where global financial markets get rewired onto blockchain-based rails. And when that happens, it means that

00:29:02 Speaker_01
every single person in the world, when that's fully complete, will have a digital wallet on their phone. They won't know that it's a digital wallet. It'll just look like an account.

00:29:11 Speaker_01
It doesn't matter that it's a digital wallet, but they'll be able, with virtually no friction, to buy any of these coins. When there's no friction to buying something, people on the margin do it.

00:29:19 Speaker_01
And when people on the margin do anything, the price goes up. So I'm still very excited about this technology, but also these markets and the potential for appreciation.

00:29:27 Speaker_02
So part of the case, at least a couple of years ago, in that store of value was an inflation hedge because of the scarcity of Bitcoin itself.

00:29:35 Speaker_02
As you've looked at how the markets have reacted over the last couple of years, how do you think about Bitcoin as a risk asset compared to a diversifier?

00:29:43 Speaker_01
It's a beautiful asset because it's sufficiently unpredictable that it makes it hard to hold. And I know that that might sound like an oxymoron, but I think that markets are built to make it hard to make money.

00:29:58 Speaker_01
So I like going into markets where I understand why it's really hard for people to do things. Institutional investors have been dancing around these assets now for a bunch of years. They got really close in 21.

00:30:13 Speaker_01
There were digital asset working groups all over the world. And then the rate hikes came and then FTX blew up and Celsius. Different funds had made big investments in venture equity and some of these things and the press beat the hell out of them.

00:30:28 Speaker_01
So these investors didn't do anything. They could have bought Bitcoin between 15 and 20,000 again. And now here we are at 95 or something like that. So they didn't get in.

00:30:36 Speaker_01
So I think what you're seeing is you're seeing an asset that's just doing its job in a way as a brutal market where the big pools of capital go, well, I only want it if it's an inflation hedge.

00:30:47 Speaker_01
But basically you just talked yourself out of buying something that is a highly convex inflation hedge over the medium to long-term, doesn't mean in any given quarter, any given year.

00:30:56 Speaker_01
At some point, it won't be that highly convex because the overall market cap will be so high and so many people will be in that it'll probably trade a bit more like gold, where gold sometimes trades like a great inflation hedge and sometimes it doesn't.

00:31:07 Speaker_01
But if I said I could design an asset that would behave exactly like investor would want it to behave under all market environments, you'd never make any money with that. things have to not make sense sometimes for it to be valuable.

00:31:20 Speaker_01
If we had perfect clarity around all of these things, the price would be a lot higher.

00:31:24 Speaker_01
So I am always looking for opportunities where I understand how other people don't understand it, I understand why they don't understand it, and I have a strong view that in time they will come to understand it.

00:31:34 Speaker_02
As you think about building a crypto asset manager, most of what we talk about in Bitcoin is now readily available at low cost. ETF movements, BlackRocks, and largest ETF. How do you think about Alpha when you're trying to build an asset manager?

00:31:48 Speaker_01
When we started the crypto asset manager, we were focused on beta products, actually, because there were not good access vehicles for institutions in this space. They didn't have ETFs. Really simple, well-structured, secure beta.

00:32:04 Speaker_01
So naturally, as you can imagine, now that we have clarity that we now have ETFs, there's really no purpose to have simple Cayman beta vehicles. So we have a multi-strat fund.

00:32:15 Speaker_01
We do trend following in that, which is, I think there'll be a lot of alpha in trend following. We have a credit sleeve. We have an opportunistic sleeve in there. We provide solutions for clients. I built OneRiver, started as a solutions provider.

00:32:29 Speaker_01
We do that at Coinbase Asset Management.

00:32:31 Speaker_01
The Coinbase brand, the Coinbase balance sheet, the tech stack that we have at Coinbase so that our clients can work with us and have confidence they have a publicly traded crypto behemoth that will stand behind its work, its strategies, its security.

00:32:45 Speaker_01
All these things are really positive. And what we're finding increasingly is that large family offices around the world we can supply all sorts of services to these guys to help them get yield for their underlying assets.

00:32:57 Speaker_01
So solutions I wouldn't call alpha per se, but what we can do is we can sit across the table from clients and say, what is your asset mix right now? How can we optimize that? How can we help deliver a higher yield?

00:33:08 Speaker_01
How can we help protect the downside while leaving an exposure to the upside? And then in our alpha multistrat, they're not more than a handful of really credible asset managers in crypto, and we're viewed as one of them.

00:33:19 Speaker_01
So when the institutions really do come, I think we've got the right portfolio mix and solutions to really help them with this.

00:33:26 Speaker_02
So alongside of this focus on bringing a lot of your core strategies together in equity markets and all, and then crypto, you've always had a lot of bespoke strategies.

00:33:36 Speaker_02
And I'm curious, as you focused on these two, what you've learned about some of the bespoke strategies that may not have gotten your current focus and attention.

00:33:45 Speaker_01
The different parts in the life of an asset management business as you build it out, and actually Luke Ellis who has been so kind to me over the years. He stepped down recently as the CEO of Mann.

00:33:57 Speaker_01
He went to the chalkboard here, the ink board, and he just drew this S-curve. And he's like, basically, when you start an asset manager, you got to figure out what works, what makes you special. And you might have to try a number of things.

00:34:09 Speaker_01
And then at some point, if you're fortunate, you figure it out. So, you're just surviving, which we did for a lot of years. And then you figure out what really works for you. And then you go into this rapid growth phase.

00:34:21 Speaker_01
And that's when you really need to narrow your focus and you need to scale. Because as you do that, you become dramatically stronger, meaning you can hire more people, you have access to resources that you didn't otherwise have.

00:34:34 Speaker_01
Then what that allows you to do is get to a new plateau where you can start experimenting more. So it was such an interesting thing for me.

00:34:42 Speaker_01
I realized that as a firm, that accelerating part of our growth, where I think we have on the OneRiver side, we have our vol strategy, our trend strategies are great. The combinations are things that other people can't do.

00:34:55 Speaker_01
So we're going to really scale here. And we have some things that we're continuing to develop quietly, an inflation convexity strategy. In this rate cycle, I think investors are going to have a lot of exposure to rates and duration and inflation.

00:35:11 Speaker_01
And there really isn't anything out there because there just hasn't been a good market for that type of strategy. So again, I like to go into the things where I understand why other people haven't done them.

00:35:20 Speaker_01
So we're still doing research behind the scenes, but we're pretty focused right now as a firm behind these strategies, total portfolio, risk responders, dynamic convexity trend.

00:35:31 Speaker_01
And then on the crypto side, to Luke's point, we've had to go through those things as well. We went through the single asset funds because that's what the industry needed.

00:35:40 Speaker_01
We created a yield vehicle where we didn't do DeFi because we thought DeFi would eventually blow up, which it did. So our yield vehicle produced really good returns and not as high as other guys, but we didn't blow up.

00:35:52 Speaker_01
And now we're at that stage where I feel like what we're doing in the multistrat is this is going to be where our growth grows dramatically as institutions come.

00:36:02 Speaker_02
As we look out for the next year, in all the conversations you have with the allocator CIOs, I'm curious, what issues are you hearing is top of mind?

00:36:10 Speaker_01
We've spent a lot of time in Asia because those are the folks that are most open to total portfolio. Increasingly, that's arriving here in the US because they've published work, they've produced outstanding performance.

00:36:23 Speaker_01
The thing that investors increasingly are talking about is capital efficiency and when you have a positive rate, so rates went up from zero to much higher level.

00:36:33 Speaker_01
And not a whole lot changed initially, but now you're starting to see people really think about what's the cash usage in a particular strategy and how do I get the most out of it. We're hearing more about that.

00:36:43 Speaker_01
The quandary investors find themselves in is if they've been underexposed to equities, they've underperformed. So they feel like they need to be exposed to that, but they're increasingly just nervous because valuations are high.

00:36:54 Speaker_01
And that's the right thing to be. By the way, last time we got valuations up into these types of levels was 2000. and then it all went wrong. But the previous time was in the 50s, and it stayed up at these levels of returns for years.

00:37:09 Speaker_01
So we don't know which one it is. I would argue that because of AI, it might be more like the 50s than 2000. It might be 2000, but maybe we're still two years before that crash, or maybe it's two months. I don't know.

00:37:21 Speaker_01
That's why I want to have portfolios that are resilient to all sorts of different outcomes.

00:37:25 Speaker_01
Investors know they need to be exposed to equities because if they don't, they're out of a job, but they're trying to figure out what to do because in 2022, both went wrong. That was the real punch to the face.

00:37:36 Speaker_01
You thought you had a resilient portfolio and you didn't. If you have looked back through history, you know that this correlation regime that we've been in for a long time, that's not the way the world always works.

00:37:47 Speaker_01
And COVID, I believe, propelled us into this new regime.

00:37:50 Speaker_01
And whether most big investors believe that that's true or not, they have to at least acknowledge that it might be true, that nothing's permanent, but we might be in for a 10 or 15 year period where the reliable correlations of the previous period no longer play out.

00:38:04 Speaker_01
What other big risks are you worried about? Let's set aside the geopolitical. We could talk about that all day. The big risk that I see in markets that I think is ignored is the risk of illiquidity. And I see it in all sorts of places.

00:38:20 Speaker_01
I see it with private equity players. When I see equity markets at all-time highs and I keep just reading the papers and private equity guys don't seem to be able to return capital to their clients, wow,

00:38:31 Speaker_01
Imagine what that would look like in a bear market. That's an example of liquidity risks that are increasing within the overall system.

00:38:38 Speaker_01
The real risk that I think is rising is that with all of these multi-manager shops that have scaled beyond belief, really.

00:38:47 Speaker_01
that are highly leveraged, the way that their risk management approach works, the way that that entire industry works, is it's a bet that you can highly lever a whole range of what you think, in most conditions, are lowly correlated pods of traders, and that when one or more of them go wrong, you can hit the bid and get out of those positions.

00:39:09 Speaker_01
And I think increasingly the risk of something that looks like 1987 is high and rising.

00:39:16 Speaker_01
That's one of those risks where the sun could be out and blue skies and everything and something happens in Japan and some weird monetary policy thing happens and a few people get stopped out and you come in and a really big market gap down that didn't allow people out and then forced selling into that gap down could be catastrophic for markets.

00:39:36 Speaker_01
and it might only last for two or three days. 1987 was a long time ago. I started my career in 1989, so I didn't even really live through that. People talk about tails and that I think is staring us in the face.

00:39:48 Speaker_02
Well, let's end on maybe a positive tail. So you mentioned earlier you could see both sides of this. What do you see as the potential positive right tail outcome?

00:39:58 Speaker_01
You have to be an optimist. I think about the downside a lot, but that is so that I can be exposed to the upside and survive.

00:40:04 Speaker_01
So first thing to do in investing is make sure you don't die and then figure out, it's like, okay, well, now that we figured that one out, now how do we build and compound? The bullish case here actually is Scott Besson coming in.

00:40:17 Speaker_01
The Trump administration is bringing some very, very good people. Kevin Hassett, who's one of our advisors, is going to be involved driving economic strategy. Scott, he sees around corners as well or better than anyone.

00:40:30 Speaker_01
If the US continues to invest and build out infrastructure and keep energy prices under control and cut government waste, and if our entrepreneurs are allowed to really race ahead with AI,

00:40:45 Speaker_01
And then a whole nother group of entrepreneurs are able in a pretty unconstrained way to use those technologies to build out new industries in robotics, but also apply those technologies to existing industries.

00:40:57 Speaker_01
The US could continue to really outperform the world, which it has. In the real bullish scenario, what happens is Europe goes, holy cow, these guys have buried us and we got to really stimulate, otherwise we face an existential crisis.

00:41:10 Speaker_01
And then China needs to maybe stop focusing so much on Taiwan and figure out how to mend ways with the US. You could imagine this hyper US exceptionalism dragging the rest of the world to do things that they've been reluctant to do.

00:41:23 Speaker_01
That's the most bullish scenario from a geopolitical and an economic perspective. I'm actually hopeful for that. I really am. I'm going to stay optimistic, but I'm going to protect our downside. Eric, thanks so much. I always appreciate your insights.

00:41:36 Speaker_01
Great. It's awesome to see you. Thanks, Ted.

00:41:39 Speaker_02
Thanks for listening to the show.

00:41:41 Speaker_02
To learn more, hop on our website at capitalallocators.com, where you can join our mailing list, access past shows, learn about our gatherings, and sign up for premium content, including podcast transcripts, my investment portfolio, and a lot more.

00:41:58 Speaker_02
Have a good one, and see you next time.