A Passport to High Returns - 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 episode is also available as an episode of the Benzinga Podcast. Be sure to subscribe to the Benzinga Podcast in iTunes.

This is part 1 of a 2 part interview.

If it takes so long for the market to learn these things, how do individual traders and investors try to take advantage of these things that are happening?

Well, everybody comes at it in their own way, timeframe, or risk profile. When you have something like China, where the Chinese stock market was completely irrelevant until about 5-6 years ago, and then suddenly you have a universe of thousands of companies you have never heard of in an economy that you previously never thought about, it takes a long time to understand what's relevant there.

We have so many secular trends and changes going on that is are hard for people to process and make sense of. Structurally speaking, we are in a very unstable, fast changing world. Everyone has Blackberries and iPads so people get this information relatively quickly and simultaneously, so I try to think about investing by understanding that markets are the equilibrium of supply and demand and not the efficient discounting of the future.

I try to align my efforts and resources to look at these big events and the industries that they effect. We try to learn from the companies involved and the structure of such situations to then construct a portfolio that we think that is anticipating something different happening.

During the debate over financial regulation reform, there was a lot of talk on the "shadow banking system" that had sprung up over the past 10-20 years outside the purview of regulators. Do you think this is a fair characterization?

No, of course not. The biggest risks that markets face are the lack of understanding of the regulators, and their inappropriate changing of rules. Another big risk is when the biggest banks take the nations deposits and then them off inappropriately with inappropriate risks. The hedge funds that have no fall back positions are the most responsible risk takers around.

Do you think that 13-F filings are unfair in the way they force hedge fund managers to reveal their strategies?

Yes, but I'm not actually so upset about transparency because I think it's a trend that we should all expect. We typically take positions and tell investors, and the world about them. The question is whether or not the people are going to believe our views. We don't mind if they know what we own or what were short.

Which traders and money managers do you follow?

Probably more the ones that have expressed tremendous skepticism about the current environment. I started 10 years ago and my belief was that the market was extremely expensive, and I have essentially been betting against the US markets since.

Now I'm in the position of regarding the government as an enormous risk toward our wealth and sovereignty. Therefore, I pay particular attention to those who have views about that because I want to learn from them and follow their thinking. It's also a means of discounting the positive stories always being heard about the market.

Do you feel a political element coming to investing over the next five years?

Yes, my first job was an emerging market fund in 1986. When you were regarding emerging markets back then, as in today, you had to do a macro analysis about the government, fiscal situation, monetary system, currency value, and industries. Years ago, Americans didn't care about the maco.

The macro had been with Americans for such a long time, which is why you have so many dedicated bottoms up investors. Now, the American government is so miss-regulated and had miss-managed its own finances that you have to look at the country as an emerging market. Essentially, you shouldn't buy a security in an unstable market if you don't understand how it may change. That is what I think we are going to be dealing with for the next 5 or 10 years.

You got a lot of press for Passport Capital's impressive showing in 2007, when its flagship fund ended the year up 219% from where it started. Could you tell us what strategies you implemented to make that happen?

About 2/3rds of the profit came from shorting sub-prime mortgages. That was a position we initiated in October of 2005, and we lived with that for almost 18 months before we really started getting pay-offs in the market. We had to basically suffer with our position basically until people who had taken out loans didn't make payments. It took that level of reality for the market to start rejecting them.

That was a key thing. I also tried to avoid the US stock market because I thought it was a long bear market. So, I started to invest in resources in other countries like India, Asia, and Brazil. My portfolio of commodities in energy, metals mining, and emerging markets had a very good year.

Also, other shorts we had in financial and other sectors in the US also started to sell off after August of 07 when the commercial bank market broke down.

Now that required a lot of patience. During that time did you ever start to second guess the wisdom of your prediction or did you stay true to your vision?


Well, the risk reward of shorting a stock is really not that good. What I knew about the sub-prime short is that we owned insurance. So, we owned 200 basis points over treasuries, essentially spending 2 percent a year to insure against those mortgages. From the beginning of 06 to September 06 the cost of protection went from 200 to 100 basis points over treasuries.

It only cost 1% for protection. Of course I lived with losing high single digits in terms of return, but I knew the risk reward was the same. It wasn't going to get worse. In fact it was getting better. The problem in 06 was that everything else was going down, yet the subprime short tightened. Credit literally tightened.

So that was the biggest soul searching, but I was really fundamentally believing these sectors and companies that had very little debt. I believed there was scarcity in great growth. At least the subprime short, you have to keep putting up money, I knew it was a limited loss.

I was able to hold on to both sides of that trade, despite losing 20% from May 06 to Sept 06. It was very painful to watch the markets change and watch liquidity coming out of the things I thought would go up a lot which they did in 07. Money poured into tightening the spreads on what was the worst credit around which was subprime. I've determined after getting a call from my biggest investor in August of 06.

They were going to take out 25% of their money out of my fund. I knew something bad was going to happen because I was losing that much money. But I decided you know what, this doesn't change reality. It has nothing to do with reality. This is how the market works.

When someone loses money they want to sell something. When they are making money they want to put more money in. They were just doing what is normal for investors. I decided that I can't change reality, this is what I think reality is. I made a decision that I was going to stick with my guns, try to protect it if I could, not take excessive risk. But that was an enormous moment, because had I caved in I never would have had 2007's return.

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Posted In: Hedge FundsMovers & ShakersMarketsGeneralBenzinga PodcastJohn BurbankPassport Capital
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