Market Overview

A Passport to High Returns - part 2 - Interview With John Burbank

John Burbank is the founder of the hedge fund Passport Capital. He is a widely followed money manager with a record of success since he launched his firm in 2000. John famously predicted the decline of the American housing market starting in 2005 and reaped a return of over 200% in 2007.

John had a conversation with Benzinga's Alex Schiff on "political risk," Pepe's Pizza and how to make money in any macroeconomic scenario. Below you will find a transcript of the interview. This is part 2. Click here to see part 1.

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Was that performance only possible because of the shorting opportunities that came from the housing crisis and impending recession or is it possible to make that kind of gain in today's environment?

We made something like 90% on our longs, gross in 07. We did incredibly well on the long side. It was really that the risk was so improperly priced. To make such high returns you need to either to own things that will triple. It's hard to have a portfolio to do that without excessive volatility. If you're not going to do that, you need to find risk that is completely improperly priced. It is possible, I suppose. We're in a world now where you have a lot of people trying to find the mispriced risk. Defend against the tails. And a lot of this insurance is too expensive now. Everyone's aware of the risks, probably because of the subprime profits we and others got. There's more attention to looking for these things.

We're short JGB's (Japanese government bonds) in Japan, believing that when you're close to 250% debt to GDP, financing costs rise enormously. But until the market rejects the JGB's, it just stays very low and you end up with a negative carry that you have to cover.

And so I say that it's possible, but it's more possible that people can't imagine can't imaging those things happening like 07.

What do you see as the most promising investment opportunity for the next year ahead?

When you say promising, do you mean goes up the most with the least loss? Or do you mean it might go up a lot or it might not?

I would say go up the most

It's a hard question. Again it's all about probability, and about the chance that it does and the chance that it doesn't. For instance I could say that the JGB trade, betting against the treasuries of any of the Western world or G6. I think eventually there's going to be a crisis in funding these relatively short term maturities. It doesn't mean it's going to happen in the next 12 months. In fact I think deflation is what's in control here. The buildup of debt that Greenspan enabled has created way too much capacity that demand can't fill. So you know, you can have a view about these things. I can imagine treasures or even JGBs rise in value because people using liquidity and the sure return to put money there instead of equities and other risky assets. The other reason not to be dogmatic is that we have no idea what the Fed is going to do. If the Fed stays on the sidelines and doesn't do anything more, I can tell you that we're going to have deflation, and most risky assets will go down in value, including equities. But if the Fed does more quantitative easing, buys more assets, and if it keeps doing it, the markets will start doing the reverse. It will start betting on inflation, treasures will come off, and we'll go down in value. To answer your question, it's a hard one, because there are very few securities or investments that will work in both instances.

In a few months from now, you'll be speaking at the Value Investing Congress. Can you give our listeners any preview of what ideas you're going to be talking about there?

I'm analyzing the government and Congress, the way that we've analyzed many other industries and markets. I've been a very apolitical person, tried to stay away from politics, and everybody I know, particularly in the hedge fund money management industry, has done the same. What I find fascinating is that we've bred a group of high powered investment and businesspeople in this country who are very dimly aware of how Washington works. Who may have biases one way or another but haven't spent a lot of time dealing with D.C. and don't have a lot of relationships there. What I find interesting is that it's allowed over the decades a very different kind of animal to assume power there. And now we all, anyone with wealth or ambition in this country, are far more vulnerable to decisions being made there with very little contact and familiarity with how things work. So what I'm essentially going to do is investigate how I think the situation is, what people can actually do from an investment standpoint, and look at it. And also articulate that if they don't do this, there's a lot of time, a few years I think, to address this. What I'm going say is, "here's where you want to invest." It's certainly not in the United States. There's another asset class of more economically free countries in the world where I believe capital and increasingly human capital will go to. Places like Canada, Australia, Hong Kong, Singapore.

You've been approached by several investors to create funds designed to hedge against "Armageddon" scenarios like hyperinflation. Tell us a little bit about your work with those funds and what they're comprised of.

In our global fund we have a number of macro hedges and trades in that fund. So the basis for what we would do otherwise is the same kinds of things we would do in the fund. The issue though is that we do not want to do trades that have to be actively managed. We want to put on trades much like the sub prime trade where we put it on and leave it on for a few years. If it pays off, it pays. If it doesn't pay off, it doesn't pay off. A lot of investors want to have those trades to be more actively managed.

Given the range of things we do, we are offering some of those trades in our main fund. Otherwise, we would like someone to invest in just one idea. We have talked to investors and you either agree with this trade or you don't. We can put you in this trade but we are not going to actively manage it. We are not going to have a few trades and worry about the monthly return. Since so many people are looking for these trades we think the market is being overdone so have waited to do this on a greater scale then what we are doing currently.

There are a few principles I stand by. Number one is liquidity. This is going to be a significant issue. You should have cash available. Second, you should not have leverage. You should have a lot less margin than you ever did before. Third, you should be diversified. You should not have all your money in one market, currency, sector, or hedge fund. You need to think like you are a Brazilian business man in the 1980's. You need to be ready for massive deflation or massive inflation. You need to have a lot your assets be able to have liquidity on them so you can make choices.

One of the single most appealing investments is physical gold. I believe the demand of physical gold is very liquid and recognized around the world. Getting your hand on physical gold is what banks and individuals around the world are beginning to do.

How do you get your news and data on the market? Are there any particular websites you visit frequently?

We use Bloomburg which is more of a traditional news service. It is very accessible to so many hedge funds. Other than that zero hedge has a lot of semi conspiracy theory reports of which are probably true. There is a wide variety of sites that are more dedicated to a particular sector or areas. A lot of times I get my news through research we pay for such as The King Report, 13D, and Macro Maven. These are probably unfamiliar to you. Most of these cost between five thousand and thirty thousand a year. We pay for this out of our research budget. If you are going to go through the internet the site should filter and provide a precise opinion about what is going on. That is more efficient for me.

Alright now that we've got the tough questions out of the way, what was your first, and what was your worst job?

My first job was as a handy man at a school I worked at when I was twelve or thirteen. My worst job was working twelve hours in a row on a hot dog cart. I did not want to eat a hot dog for a year. The first job I had during college was responding to an advertisement that turned out to be selling cookware door to door. That was really hard. I am not an extraverted person who would like that. I did that for two summers and learned a lot. I knocked of forty doors trying to sell overpriced cookware to women.

I like to tell people that big changes happen all the time. You can use your made intelligence and hard work to organize what seems like a chaotic world. Find ways of sticking to your guns and having a position that over time will conform with reality. I think that is why we have done well. At the same time you have to be thick skinned, and not believe what everyone tells you. That is how you are going to make a lot of money on certain things. My biggest concern is what to believe and not to believe with the government.

What do you enjoy doing outside of finance?

I'm a huge baseball fan. I follow baseball pretty closely. I like other sports too. I love the strategy inherent in baseball. I like things where I can use my mind. I also like living in northern California it is beautiful. There are a lot of things to do. It indulges a lot of interest of mine that have nothing to do with investments.

What is your favorite restaurant you've ever been to?

A restaurant that I particularly like is a small Italian restaurant in Hillsburg California. I guess from a career perspective it would have to be PePe's Pizza. They have the best pizza on the East Coast.

And this last one is our trademark question: What was the best, and what was the worst investment decision you ever made?

The best investment decision was to start my hedge fund. Even though there was no chance for me to make money for a number of years. I say that because I grew financially and personally. The worst investment decision was holding onto our core investments in emerging markets heading into 2008. We were not able to get out of them because of how the government acted. It's a funny thing because your best investments can be your worst one's depending on how the market changes.

Posted-In: Long Ideas Short Ideas Hedge Funds Movers & Shakers Global Economics Markets Trading Ideas

 

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