Letter #204: Rick Gerson (2019)
Founder of Alpha Wave (fka Falcon Edge Capital) and Founding Member & Managing Director of Blue Ridge Capital | Hedge Funds Opportunities in Modern Markets
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Today’s letter is the transcript of Rick Gerson’s responses on a panel titled Hedge Fund Opportunities in Modern Markets. On this panel, Rick introduces his fund, shares some of the themes he was excited about going into 2020, and discusses his evolution from equity long-short to event-driven, special situations, and why.
Rick Gerson is the Co-Founder, Chairman, and Chief Investment Officer of Alpha Wave (fka Falcoln Edge). Prior to founding Alpha Wave, Rick started his career and spent 15 years at Blue Ridge Capital, which he joined as a Founding Member in 1996 and ultimately left as a Managing Director.
I hope you enjoy this discussion as much as I did!
(Transcript and any errors are mine.)
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Transcript
So it's been a very difficult environment for active strategies to really outperform because the market has been going up and up. Having said that, we are at a pivotal point in the industry, where opportunities are looking incredible for the hedge fund industry. So I'd like to hand it over to our panelists…to introduce their firm, but also address some of the themes that they're most excited about as they looked to 2020, but also the near term.
Rick Gerson: Rick Gerson, Falcon Edge Capital. So in most businesses or services, they have to come up with a product that's differentiated that people want. And they have to go about this in a competitive environment where they continually develop and adapt, and importantly, know where they want to be.
But for some reason, in our industry, people don't do this as much. They just sort of invest, for the sake of investing, without having a clear mission, a clear goal, that's differentiated just as it would be for any other product or service that you encounter in your everyday life.
So, recognizing this, what we try to do is to think of it as coming up with something very specific, that's different, that we do, like any company would, that makes a product. So for us, it's to create an uncorrelated return stream for our investors. Simple as that. Uncorrelated to the market, and also uncorrelated to any macro factor, like interest rates or the price of oil or credit spreads. But the big one is uncorrelated to equity markets.
So if that's where we want to be, if that's the end goal, then we have to reverse engineer, just as if we had a product that we knew we wanted to make, we have to reverse engineer how do we do that? How do we create this uncorrelated return stream?
And the way that we do it is in a highly systematic and organized approach where the individual positions themselves have to be uncorrelated. Either because of the nature of the security, it is physically uncorrelated, or it has to be able to be expressed in a way that makes it uncorrelated. Otherwise, it's difficult for us to do.
But that's only part of the equation. And we have a system that helps us capture this in a factual way. The other half, if not two thirds of the equation, is how it comes together.
So we have a system that ensures that the portfolio of these ideas, the aggregation of these ideas, is uncorrelated. And anything that makes it through the first filter, and the second filter, creates a portfolio that's uncorrelated. And uncorrelated means that in down markets, we should be able to do well. And it doesn't mean that we're short biased or that we're a put option on the market, but that it should be able to do well in a down market.
And so just to kind of sum up, there's an--probably get into this more later, there's a time to be aggressive, and there's a time to be careful, and to be prepared. And it seems to us that this is a time to be careful and to be prepared. And so in the end, we try to create this uncorrelated return stream that's totally disconnected from anything else our investors have, or the market.
Rick, you started your career, or the formative stages of your career, at Blue Ridge, one of the most prominent equity long short hedge funds. Equity long short as a strategy is going through a number of structural shifts, where Beta is essentially replacing a large part of it. And so the business you run today is very different. You've evolved. You're doing event driven, special situations. But you're specifically looking at opportunities that are off the beaten path. Is that driven by this very historically low interest rate environment? Or is there something else? And can you talk a little bit about that?
Rick Gerson: Yeah, that's an accurate observation, that the old way of doing things in our industry, if you go back from, let's say, 1980 through the mid 90s, was there is a way to really make alpha by finding good companies and buying them, and shorting bad companies, and letting time shift between the two of them. This has become not only difficult, but in some cases counter-intuitively wrong.
And recognizing this, we've evolved, as you accurately said, to an uncorrelated model, which requires us to be in these special situations, that by themselves removed Beta. Beta is great when the market goes up with no volatility. But the key to be able to take advantage of dislocation is to not be dislocated. And it's not hard to predict the short term market movements or the economy, it's impossible.
That being said, there are signs that you can look at that can inform you if you're in a period of time, that is fairly late. And so just a couple of highlights that suggest that: one is, at some point, we're going to run out in the US of people who are unemployed, yet not have any wage growth in order for the [smashing] that continue. Second thing is, as Jason was alluding to, corporate debt issuance and leverage ratios are approaching not cycle highs, but all time highs.
And this isn't a backdrop of something absolutely staggering that we're used to because it's been here for a little while, which is a third of all government debt actually is a negative interest rates. And if you account for inflation and look at real rates, it's like two thirds of government debt, you're going to lose relative to even inflation.
And so to have corporate debt, let's say if you compare debt to GDP at all time highs, what is a particularly interesting warning sign is that there's two things that that tend to lead equity markets, in the debt markets. One is cashflow coverage. So leverage ratios. About 12 months or so ahead, historically, has been a pretty good predictor. And the second thing is M&A activity. Both are at all time highs, with another weird thing where the leveraged loan market is now bigger than the high yield market.
And so you put all these things together, and it makes sense, if you have a long term perspective, to say, Okay, I don't know when the cycle is going to end, but when it ends, it's not going to be pretty. And I want to be in a position to take advantage. I don't want to be dislocated, I want to be the one who sits there, like in 2009, when Berkshire Hathaway was liquid as could be and issuing converts to companies all day long. And so I think this is the opportunity. The opportunity is to be in position to take advantage of the coming dislocation.
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