YouSaid · the spoken record

Zed Francis

lines on the record: 131
first: 2022-11-14
most recent: 2022-11-14
sittings or episodes: 1
sources: podcast

Every line below is reproduced as it was said and linked to the record it came from. Nothing here is summarised or generated. Directory · Search · Corrections

“So those are actually two very, very different things. So, you know, the amount of product that's been created over the last decade that have embedded options of some variety in them has grown significantly. And that's as simple as everybody wants yield of some variety. It was really hard to access yield from traditional methods, buying treasuries, buying credit, so on and so forth. So of course there's going to be creation of something that suffices that need from the marketplace. And the easiest way to generate something that mimics the concept of yield is embed selling options into it somewhere. Now, most of that product is sitting in private bank universe that they're selling to institutions, that they're selling to high net worth individuals, so on and so forth. But it's mostly in the private bank world via some sort of structured note or something that looks like a structured note. In that product, they're almost always selling.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Said To what degree were derivatives sort of popularized over the past decade that relied upon ultra low interest rates that would not go higher and really juice as much yield, say, oh, I'm only getting 90 basis points, but I can eke out a few extra basis points if I enter this complicated derivative. That makes money no matter what. I mean, unless the Fed hikes by 400 basis points in a year, but I mean, that never happens. I know you followed the UK guilt crisis in late September of this year where pension funds who had entered into liability-driven investment schemes were basically forced to sell their bonds at fire sale prices in order to make good on those derivatives. Worldwide, not just in the UK. And how are you sort of handicapping the odds of the bond market, quote, breaking like it broke in the UK guilt market in late September”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“All assets have some portion of duration to them. And so anybody that holds assets is long duration to some aspect. And people that think that like, I own a bunch of equity is like, I don't own any duration. You're like, no, no, no, no, no. You definitely do. It doesn't mark to market exactly what rates are doing every single day. And it's not perfect bond math calculation like you wouldn't fixed income, but you definitely do. You definitely own some duration. We can argue about how much, but you definitely own some duration. So essentially anybody that holds assets is long duration. And that's why in a year that we've experienced so far with a significant move in interest rates, that all assets pretty much anywhere have gone down. And it's a duration component of all those assets that are the main driver of those increased correlations and why everything's having an issue.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“So, I mean, like, go back to the first thing you said. So think about it, if traditional bank procedure essentially makes them short duration, that means they're very happy to take the other side of that. That's like a natural hedge in their portfolio. So if somebody has fixed and they floating and they want to make it fixed and so they're going to enter that swap to go ahead and go from the duration exposure to no duration exposure on their side, the banks are just sitting on the other side of that transaction like perfect. Like that gets us to head. So that's a simple environment to be frank. Like it gets everybody to like neutral because they're just on the other side of the transactions on basically both sides. But the ultimate holders of duration or basically any asset holders. Like again, like all assets have some component of duration to them, whether it's de minimis or a significant amount of duration.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Say, you know, I have a real estate company and I'm borrowing money, so I lose money when interest rates go up because I have to pay more in borrowing costs. But I say, oh, Zet, don't worry about it. Like it's hedged. I have to hedge. I've entered a fixed rate. I've entered a swap shop. It's all good. Don't worry about it. But it's like someone who's on the other side of that, they have to now endure that loss. You can't negate the losses imposed on the financial system by central banks and by raising rates. You can only transfer them. So who sort of gets left stuck with the bag with all of this duration risk? Because, I mean, there's an enormous amount of just the asset class of two-year treasury notes is enormous. And people have lost, oh, I don't know, 8% on that money, which they normally think of like as kind of cash like. Maybe they shouldn't because they've been used to zero interest rate volatility world, but or close to zero. But yeah, I mean, who bears these losses?”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Would be utilities. Utilities in theory are kind of a shorter duration sector, but there's been a lot of, we'll just call it financialization of that sector, i.e. they've borrowed a heck of a lot of money to increase returns for the equity holders and dividends and so on and so forth. So the fundamentals of the business are short duration, but the company construction themselves is not exactly the case.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Hopeful, along with it being a short duration sector. But like financials, like, you know, because there hasn't been an expectation of massive defaults, like that would be a different story for the financial sector. But at this point, everybody's like, well, you know, we're kind of just bumbling along. It's not great, but it's not terrible. And we don't see lots of defaults and they haven't really massively increased their loan reserves yet or anything because they're not nearly seeing those defaults. All right. So what are they worth? And you're like, well, they're a high free cash flow today type of business. Basically, their R&D is people, which is today money, like out the door. And we get returns from that money over the next one to three years and pretty front-loaded. It's mostly servicing fees. So it's like, it's a really low duration sector. And so that's been very beneficial to it. An odd one that you got to go company by company, to be frank.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“I mean, like, I think probably the simplest way to refer to it is sectors that tend to be short duration and sectors that tend to be short duration are kind of like financials, commodity type players. And anybody that's basically like I, you know, do some R&D or CapEx and then in three years I expect to get most of my money back. That is a short duration type of company and or sector. So yes, and on the commodity side, commodities have also gone up. So that's, you know.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“I should have explained this earlier, but duration is a concept that refers to how far you're going to get your cash back. And that's sort of the concept, but it's also a very mathematical formula for just how much money you're going to gain or lose if interest rates go up by X or Y amount. Which assets have short duration and have weathered the storm better than others? For example, unprofitable technology stocks, a 30-year bond, both of those have long duration. You're not going to get your cash flows for a long time. And they've suffered the most this year. What do you think of the asset classes? And you can pick your choice that have done much better. And to what extent do you attribute it to, oh, it's because they have shorter duration?”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“In the space more broadly. So we haven't seen it yet, but there is a mechanism for it to happen. And that's probably when you see more alignment with, you know, private markets and public markets.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Aggressive fruition yet. There hasn't been a lot of trading necessarily happening there. But when people need some liquidity and they say, all right, like, I don't know if I necessarily want to sell my public market stuff down, you know, whatever, I guess only 18% or something like that. But, you know, I don't want to necessarily sell that. I want to look at my private's portfolio to get some liquidity. They're going to call those venues and those venues will make them some sort of bid. And as soon as somebody says, you know what? I think that's good enough. I'll take that. I'll take whatever it is, 50, 60, 80 cents another. I don't know, but wherever it is, that will start the repricing because then all of a sudden you'll have a chunky trade, you know, a giant pension that has 50 billion in private sells $5 billion to Goldman. And this is what those holdings are. And that's going to force a little bit of a reck.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“But there are firms that will go ahead and basically make markets a secondary private investments, whether it's a private equity fund or a single investment and so on and so forth. And the main ones that really do it are Goldman's pretty big in it, like JP.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Yeah, I mean, I don't think either side is the truth. I don't think there's a known valuation for anything. Everybody is doing their best guess and coming up with a market-based pricing. And that's the difference is, you know, most other assets to have that truly daily market-based pricing getting to some sort of clearing value where there's a buyer and seller and they meet. And that's the price for that point in time, where again, the private market says not necessarily the case. So, you know, there's a handful of firms out there that will participate in liquidations of locked up private assets. So say, you know, all right, you're in some sort of private equity fund and they called your capital and in theory you're locked up for five years. We're getting some distribution and then there might be a trail where you're getting future distribution. So on and so forth. But you're like, I can't actually go sell it somewhere naturally or”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Yeah, super traditional carry trade, which works really well nine out of 10 years in the 10th year tends to not be very fun. Yeah.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Right, and a lot of private equity, correct me if I'm wrong, is funded with relatively short-term debt or floating rate debt. Like it's not, you know, Amazon a year and a half ago, they took out a 40-year bond. Which they got at like 95 basis points over treasuries. An extraordinary good deal that they're actually benefiting from duration risk there. Private equity, it's the total opposite of that. It's like, you know, a year term loan that's LIBOR plus 300 basis points or sofa, you know, plus 300 basis points. So as interest rates rise, they're basically, you know, it's kind of like an industrial mortgage. They're not locking in their rates. And they're using that. So they're using their short-term borrowing to fund longer-term assets, which does not do typically well when interest rates rise.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“More like financialization in terms of duration, have you? But essentially, like P is borrowing a bunch of money today to buy a long duration asset. So it's a carry trade plus a duration exposure. And neither of those have been good in this movement of a curve flattening in interest rates and interest rates obviously selling off. It's costing a lot more money to borrow today. And your asset that you purchased that is a long duration asset is also being discounted at a much higher rate. So it's the double whammy of your cost of financing is up and the asset that you purchase is probably worthless. Right.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Exactly. Like the real key is that specific company, you're valuing even when an IPO is probably based on cash flows that are pretty far out in the future. So it's like the ultimate long-duration asset. Negative cash flows today with really big cash flows in the future. That is the definition of extremely long duration. So even if the companies haven't fundamentally changed, they should just have a lot less value today because, you know, again, rates have moved a heck of a lot. When you go to the PE space.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“I think the fun one is privates because I think people kind of ignore privates a little bit because they don't get marked every single day. So you can norm from that standpoint. But for this conversation is most private investments have exceedingly long duration to them. So VC super simple, right? You're like, all right, I give you some money today. I expect you to lose a bunch of money for. One, three, five years. But guess what? In your 20, like tons of free cash flow, right? So”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“I totally agree. And the 10-year treasury is at like 4%. The SP 500 PE is less than 20, but let's just say it's 20. A PE of 20 is earning 5% a year. So that's like getting a 5%. So equities are paying more than 5%. Not that you're getting that in terms of the dividend, but they're reinvesting that. So yeah, equities are fundamentally a better long-term investment than bonds, but that's because they're riskier.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“No, do not disagree with you. I'm just in the discounting of future Castro's conversation, just saying if this were to take place for five years where inflation is a lot higher than people think, equities are likely the least bad choice, purely because their cash flows are variable rather than fixed. Yep.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“But the rate, so I'm not someone who worships at the altar of rates. So, oh, you know, it used to be 20% increase and now it's only 10% increase. So that's bearish. Like a 10% increase is still good. But just looking at the second derivative, like, you know, earnings grew what, like 30% in 2021, and now they're growing at 5%. And a lot of that is energy if you take out oil stocks, which are doing extraordinarily well financially, then it's pretty close to zero. So you're going from like 30% to zero. So what's next? I mean, you know, the Fed is not the Fed is not going to ease. Anytime soon, so that the interest rate pressures on the interest rate housing auto market, the economy's not looking great. That's what I'm saying.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Earn Equities are likely the least bad choice if we continue on this path simply. And frankly, that's an underperformance if you think about it. You're like, okay, if inflation is 8%, top line should be growing 8%. There should be benefits for you running an efficient company that earnings don't go up 8%. They should go up more like 12%, right? You know, there should be some scale associated with the top line growing at that speed. And they're only up five and a half, you know, kind of approximately thus far. Companies aren't doing as well as you'd expect with a top line growth of 8%, but it's still a positive number. It's still growth. And frankly, it's still above the quote unquote risk-free rate. It's hard to say that, you know, this is horrific for equities yet.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Let me just say a few things, summarize how I think, and tell me if I missed anything. All assets have a duration exposure, exposure to interest rates going up or down, and most assets are less valuable when interest rates rise. Historically, that's been shadowed by the fact that typically when interest rates rise, earnings rise as well. So sometimes you see the stock markets go up. But in this case, that has not been the case. The economy has slowed as interest rates have risen because central banks are tightening into a slowdown. So it's kind of like the worst of all worlds for a lot of asset classes.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“I mean, like, similar as if you had a 30 year standard treasury, and if the interest rate on that treasury was zero, the duration on that is going to be high 20s. You know, you move the interest rate at 30-year treasury up to 3%, the duration on that is like 21. You move it up to where it is today. It's already down to 15. So every percent change in interest rates back when it was zero created almost a 30 point move in the dollar price of the bond. And that's already down to 15. You've already cut the amount of movement per 100 basis points, 1% move in that 30-year treasury in half. And essentially that move that we've experienced. So it's just becomes less and less sensitive because your duration becomes shorter and shorter as rates become higher and higher. So that's why it's problematic going from zero to five, just round numbers and five to ten less so.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Right. So when interest rates go from 8% to 12%, which means that cap rates are the sort of the valuation of real estate goes from, let's say, 10% to 15%, that's not as bad, you're saying for two reasons. One is just the math, which you can explain. I can't explain it. And two is that as it's going up, as the valuation is going down, you're still getting that 10%. Whereas if you bought a zero coupon bond, you were getting zero as the bond price was falling. So a lot more interest rate sensitive when rates start from a very low base, which is exactly what we had.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Late 70s, early 80s going from 8% to 12%, real estate, in theory, might have been a very good investment simply because, hey, it's a hard asset that's experiencing some of the benefits of the rest of the world devaluing from an inflationary perspective. But when real estate was hyper financialized, meaning like cap rates of three and a half percent, we're putting as much leverage. That's how we're creating a bunch of money is we think we can get to distributions at 6%. We can borrow at three and a half and you lever it up six, seven times. That's really bad when you go from zero to five percent in interest rates.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“State, ultimately, you have some flexibility to go ahead and increase rents and increase your cash flows. But if you think like commercial leases are five plus years, so the reflexivity is not necessarily automatic. It takes a little while for them to go ahead and increase rates. And even in the residential kind of space, if you have any sort of residential real estate multifamily investments, they're not happy right now. A lot of that is they got pulled down in 2020, 2021 in terms of what they could actually ask for rents. And they're going through the 12, 18, 24 month cycle to go ahead and resize those rents to the current marketplace. But there's a delay there, right? And so even real estate, I think, has problems in an inflationary environment when you at this starting place of zero rates. If you're going.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Equities are likely to be the best place to set because their future earnings are probably also increasing somewhat close to inflation. So cash flows from the equity ownership are going up. Yes, they're being discounted at a higher, higher rate, bringing their present value down, but at least there's some increasing future cash flows because they're potentially earning more due to higher inflation. Other investments are less likely to be the case. So if you have some sort of, you know, we'll call it securitized fixed income investment. Again, it's fixed income. You know the distributions that you're going to be receiving Sanzani defaults and you're just discounting those back to today using some leverage to dial up those returns. Again, the known cash flows in the future are fixed. That's problematic if inflation's higher and rates are higher. Real estate kind of similar. I mean, real estate.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“So, I mean, ultimately, I actually think you're correct. I think the best asset class to hold when interest rates are rising are equities. Now, it might be the best of a bunch of bad choices, but ultimately I do think that they're actually the best asset class of everything you could possibly have simply because their cash flows going on into the future. As you said, have a variability to them where a lot of other investments, those cash flows are somewhat fixed. And so what we've experienced round one, I think, is because it's been shocking to most people, the move, is that revaluation of equities from a multiple perspective. But I'm not saying equities are necessarily cheap, expensive, whatever here. But if we continue on this path of reasonably high inflation, driving potentially higher rates.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“Not that complicated, what we've had over the last 12 plus years, and it was happening beforehand, but really accelerated the last 12 plus years, is the financialization of everything, which essentially means you're trying to squeeze out every bit of potential equity compensation by adding leverage wherever you can. And the baseline for leverage is going to be treasuries. Is treasuries plus a spread, but treasuries is ultimately the main driver of what is going to allow you to finance something, whatever asset class, to go ahead and squeeze more and more value into the equity portion of that investment. And so ultimately, what that means is all investments are going to have pretty significant reflexivity or correlation to the level of interest rates.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT
“I am joined by Zed Francis Chief Investment Officer of Convexitas. Zed, great to have you here. It's an interesting time. You're a rate sky. You have a background in rates, but as the name of your company might suggest, your firm focuses on volatility. So volatility options in equities, as well as rates. But you have a background in rates and interest rates has been at the absolute sort of eye of the storm of what's been going on this year. And you had a piece out a while ago called rates-free risk, duration, duration everywhere, basically how interest rates is the greatest risk ever. And that was actually wow. That was published in February of 2021. So nearly going on two years, and that was very prescient. So tell us why you thought that duration was the sort of biggest risk to the market and walk through your thinking.”
2022-11-14 · Forward Guidance · Forced Retirement Selling May Disrupt Santa Rally | Zed Francis · IDENTIFIED FROM THE TRANSCRIPT