RAOUL PAL: Diego, good to get you back. It's been a while since you and I have chatted,
you've been on Real Vision a few times. I think maybe, just to start, just introduce
people to what you do, and how you look at the world because I think it's a really interesting
time. You've been coming on Real Vision over the
years, you've built your thesis, and now, it's all playing out. Let's go through a bit of that first, bit
of background. DIEGO PARRILLA: Well, thanks for having me
back. It's been over five years, I think, since
the first appearance and early days of Real Vision. My background is I'm an engineer. I'm a mining and petroleum engineer. Originally from Spain. I did my thesis in mineral economics and specialized
in real options. That really changed my life, changed my career. It gave me the opportunity to start in investment
banking in London in the mid to late '90s. I was trading FX and precious metals with
JPMorgan. Then I was with Goldman and Merrill which
was eventually leading globally the business. On the commodity side, I was in London. I spent some time in New York and Singapore,
where I spent a lot of time with Grant. Then I moved on to the buy side with my own
firm. Also, with some large macro players, like
BlueCrest, or Diamond, before I eventually made it back home to Spain where I'm managing
partner for Quadriga Asset Managers. What got us together, I guess it was my third
capacity, so not just been on the buy side and sell side, it's been my capacity as a
book author. As you know, I have two books. The first one was called, The Energy World
is Flat, which I co-authored with our good common friend, Daniel Lacalle. That, at the time, was putting forward a very
contrarian thesis to the prevailing consensus of the market. $120 oil ,200 Peak Oil theory and I'm a contrarian
by nature. I look at forces, I look at equilibriums and
there were a number of relationships and beliefs and misconceptions that were just bound to
break and so the flattening of the energy world is a thesis not only survived, it's
actually been reinforced with [?] time. RAOUL PAL: That is a brilliant call. It was a book that I read, it changed my mind
immediately. I'm like, yeah, get it now and that's been
dead right, and I think it will remain so for a long time. DIEGO PARRILLA: Yeah, I think the-- you analyze
the forces. It's more about the framework or how these
forces interact and it was a fascinating process just right in it. As I always said, you think you know it until
you try to put in writing and then you realize, maybe you didn't know it that well. I certainly learned a lot through the process
and that led to the second book called, The Anti-Bubbles, where, once again, I guess I
put forward what, at the time, was a very contrarian thesis challenging this idea of
monetary and fiscal without limits and what had to give in the subtitle at the time, Lehman
Squared, Opportunities Heading into Lehman Squared and Gold's Perfect Storm. I think both books ironically started out,
if you went to the airport, you could find them in the science fiction department. Then through time, they made their way to
Current Affairs and some of them are going to go into history because as you said, I
think this is just a big game of chess. Some of us might be a little bit ahead of
understanding these dynamics or challenging or trying to assess them, and you see how
the pieces are moving and how these developments either reinforce or not the thesis and you
need to stay very humble and very flexible, and here we are in a historical moment with
unexpected events, but nevertheless they're part of the game. RAOUL PAL: Talk us through when you sat down
to write the book, what was in your mind? You were looking forward thinking, look, there's
some probabilities of some certain factors that you thought were going to create a lot
of problems. Talk us through the thesis and then let's
bring us up to date with where we are now. DIEGO PARRILLA: On the Anti-Bubbles, what
really got me totally shocked-- and this is the first line of the book, was negative interest
rates. I felt that, to be honest, until that point,
we were flirting with the limits of monetary policy but within the boundaries of what was
considered to be fair game or the existing rules. If you're talking about zero interest rates
and printing of money and buying government bonds, yeah, it's questionable, but it was
certainly within the boundaries of the game. To me, negative nominal rates were just a
complete change in the rules of the game, it had a number of implications. That's what really got me very worried very
much thinking about, okay, is it as simple as this? Are there limits? Can they just continue to do this, and how
is this all going to end? As you start looking through a lot of those
implications, of course, the minute you have assets that are discounting future cash flows,
the PV of a cash flow in the year 2200 is greater than next year's, it's just like,
what are we talking about? This whole nonsense would clearly have an
impact in asset valuations. I remember there were lots of things that
were very early days, you remember well Larry Summers' article in the FT where he was talking
about-- it was called the prudent imprudence of fiscal expansions. I read it like five times, and I was like,
what the hell is happening here? He was basically talking about like, look,
once upon a time, we had a world where we have prudence, we had the budgets, the Maastricht
was based on 60%, but this is history because this was a world of 5% interest rates. At zero rates or negative rates, we can afford
a lot more debt and I was like, look, you're building the house through the roof, this
is complete nonsense, and what am I missing? As you think through this, and you start scratching,
you realize-- effectively, one of my favorite lines on the book is the way I would summarize
the previous decade, which is effectively the transformation of risk free interest into
interest rate risk. This is really, in one sentence, what happened
throughout the last 10 years. We went through a big crisis. Once upon a time, we have 10-year bonds paying
you 5% nominal yields, and before you know it, 30-year bonds are paying you negative
nominal yields. This transformation from risk free interest
where we were legitimately earning 5% per annum with no risk, and by the way, that 10-year
bond at 5%, in the event of a crisis as yields went to zero, would make you 50%, which meant
that the whole construct of the industry, of a 60/40 balanced portfolio was based on
this set of rules. What you've seen is the transformation of
this risk free, most people-- I don't even know if they're still in the textbooks. They were there when I did went through this,
but it was a pretty fundamental basic part of how you value things. Then you go now to a world where basically
that risk free is being totally distorted to a level that goes beyond any reasonable
explanation with negative yields, and that's just in nominal terms, I'm not even talking
about real, where the thing is very deep. This is deeply troubling. This transformation of risk free interest
into interest rate risk has done nothing other than delaying the problem, it hasn't solved
the problems. It has kicked the can down the road, so it's
delayed the problems. RAOUL PAL: What is the problem? The problem is debt, I guess. DIEGO PARRILLA: The problem is debt, I would
say that is a dependence on debt, but the problem, if we start going farther back, I
guess it's this-- you could go and start pulling the thread and how far can we go, but I would
almost go to this disbelief. At the end of the day, a lot of our biggest
bubbles are built on beliefs, where the emperor had no clothe. One of the biggest ones is this idea that
you can actually solve problems with monetary policy and fiscal. The biggest misconception around is you can
actually print your way out of a problem, you can actually borrow your way out of a
problem. The debt problem only comes after artificially
low interest rates. You would never have the problem of debt,
whether it's at government level or any other, if we had interest rates pricing reality. It actually, you start going back and you
see lots of things that happen. Every single crisis is dealt as such. Hey, we have emergency measures. Let's take some extreme measures that are
meant to be temporary and exceptional, only to be permanent and totally standard down
the road. I think monetary policy is at the core of--
and the system was doomed to fail from day one because you are effectively given the
printing press and the ability to distort the value of money, time value of money. As a result, anything that is cashflow related
that requires some discounting is distorted by bringing interest rates artificially low
and having the ability to print that money, the left pocket lend to the right pocket. The Federal Reserve can lend to the US government. You are in that situation where once upon
a time, we had independence of central banks. Voltaire wisely said paper money eventually
converges to its intrinsic value, to paper. He said it wisely a long time ago because
they knew perfectly well that the system only would work under certain rules, and we go
back and we know where it all takes us to, but I think this is all, this domino effect
of short term measures where we are trying to get out of the problem with this short
term mindset. Politicians are there for the next four years
if lucky, and nobody wants things to fail in their face. By this desperate and overconfidence on monetary
policy, you slowly create the process that is meant to be domestic like the US QE 2008
response has been widely acknowledged as a big success. That's true if you're in the US. If you're in Europe, you saw Eurodollar going
to 150 and how your monetary orthodox basically puts you at a massive disadvantage, not only
versus the US but also versus China, whose currency was pegged. The 2012 crisis is nothing more than effectively
a side effect of the 2008 being transferred through currency wars and others. That shows you why monetary policies is a
contagious and relative game. The only reason we have zero, we have negative
interest rates in Europe, let's not fool ourselves, is the Fed was at zero. Draghi walked in, he had to do whatever it
takes to save the euro. He had to effectively try to devalue. We would have never ever, ever had negative
interest rates in Europe if the Fed had been at 2%. Never. This is a relative contagious game that is
sold as a domestic but there's big global balance. RAOUL PAL: Now, we're in a really fucked up
world where everybody's at zero, [?] India, South Africa and a few others. Basically, the entire developed world at zero
rates. How does anybody manage anything without just
getting more and more extreme? Doesn't that delta of the extremity get even
sharper? DIEGO PARRILLA: Absolutely. It's subject-- there's several dimensions
to this. One is clearly the law of diminishing returns. Even if at a domestic level, think about how
far those $700 billion of money printed got us in QE 1. It was a pretty simple process. You sat the banks around the table and you
said, look, we have a systemic issue. Hey, Mr. Goldman, how big is your problem? Mr. Citi, Mr. Merrill, whatever? Collectively, if I remember correctly, it
was 600 billion. They said, done, let's bring 700 billion. People were outraged at the time, but it was
much needed to print that money to avoid something else. QE 2, so I would argue QE 1 was needed. QE 2 was questionable. QE 3 was a massive mistake. QE 3, if you remember, was actually called
QE infinity. They no longer could just do QE, they had
to say we will do whatever it takes, infinite amounts, and the market didn't blink. It was already at the point where you need
to do huge amount of printing to get very small benefits. When you do this, as you said, in a multidimensional
world, where everybody's doing the same thing, then it becomes even worse, and maybe explains
things like negative interest rates in that desperate effort to devalue your currency
artificially to impact current account versus capital account balances, and things like
that. At the end of the day, this is all a fallacy,
because we are not really solving any of those problems that we started with whatever they
were and they accumulate in the system, we are delaying them. We are certainly trying to transfer them through
currency wars. We are certainly transforming them into things
like inflation. This is obviously the biggest, one of the
biggest areas of focus for us, and what the next decade will be about and ultimately,
enlarging those problems. This comes in multiple forms, whether it's
inequality or bubbles or stagflation, many of the things that, unfortunately, seems to
be the unavoidable path that we've taken. RAOUL PAL: One of the things I've been looking
at is in this whole equation is the Federal Reserve and the central banks understood a
liquidity crisis, but we're probably in a solvency crisis, because once you get to a
certain level of debt, and then we've got this extended period of slow growth, well,
there's no way of generating the revenues that you need to pay off the debt. You feel like, okay, how do central banks
solve the solvency crisis? Well, the only way is to put it on the government
balance sheet, and then back on to the Federal Reserve. This becomes much more problematic, I think. DIEGO PARRILLA: Well, they've actually gone
farther. The once again, when you think about the Federal
Reserve just printing money to lend it to the government, who in turn, will either spend
it in some ways, that's fine. We knew that. They've actually gone way farther because
now, they're actually buying high yield or even equities in some parts of the world. The money printing, and I think it's very
interesting if you think about the recent crisis where we have effectively things exploding
in every dimension. We have an energy crisis, we have the airlines,
we have the consumers, the producers, we have everything. The unemployment, the debate, what the US
is doing, as the Fed has figured out, they said, look, I have all these unemployment,
I'm going to have to pay for this one way or another. The airlines blow up, that means there're
layoffs. I'm going to have to pay for benefits. I have less income. You know what? Instead of just closing that circle, because
I know the movie, I'll just print the money up front, give it to these guys and hope that
those jobs are maintained. By basically going that way, what have been
really one of the things that has been blowing my mind and this is just a reinforcement of
the thesis is what are the limits? What stops the Fed from just-- in the oil
market, you remember when oil prices were negative? The idea was, look, let's just print money
and buy oil, we'd just buy it off all the guys. Then it was like, well, what do we do that? Well, we'll have to physically store it somewhere,
and someone had this brilliant idea-- I know it was never really implemented, but it shows
you that this mindset of, we'll just buy it off the ground from the producers. You are like you don't even have-- at that
point, you realize that they just feel like they can print infinite amount of money and
buy anything they want, effectively in any form, whether it's government bonds, or oil
in the ground or bankrupt airlines. The question is, what are the checks and balances? What's stopping this process? How is it really as simple as this? What you see in a way is there a couple of
things that go. One is if you are holding dollars as a reserve
currency, you were doing it in the hope that you won't get an Argentina or a Zimbabwe or
whatever you say there's some a process there's some control, but once the Fed blatantly tells
you, I will do whatever it takes just to prevent this thing from imploding, two things will
happen. One is the currency goes. This is why the dollar has been under so much
pressure. The second is inflation, and inflation is
coming. I think this is perhaps the most misunderstood
part of the equation because people, we can look at-- I have this debate all the time
and people go, Diego, come on. You're talking about inflation but look at
all the deflationary forces in the system. We have unemployment. We have demand destruction. We have this overcapacity. We have technology of course. We have demographics. We have all these deflationary forces kicking
in the system, how in the world can you be talking about inflation being a problem? What we need to understand is that inflation
is 100% a monetary phenomenon. It's not about the value of your house going
up. It's not about the price of bread going up. It's about the value of the money that you
use to buy your house and bread going down. Once that clicks in your brain and you understand
that effectively, we are filling that deflationary gap, which is huge, and the central banks
are fooling everybody by saying multiple things. The first one, that inflation is just one
number. Look, your inflation basket is different from
mine, is different from every single one in this. Don't fool yourself by inflation is 1.2. Go to the supermarket, and you'll realize
what it is. Inflation, that's not a real number. It's very different. It's already happening. You have this situation where the bigger the
deflationary gap, the more room were given to central banks to print even more money. They're doing it in a way where now, the US
is even blatantly walking away from the 2% target, talking about a symmetrical target. It's like it's okay to overshoot on the upside. It's written in the wall. It's for everybody to see what's coming. I think this is really the way I would summarize
the next decade, is the transformation of bubbles. Let's not fool ourselves, all we did with
artificial low interest rates and this insane amount of desperate search for yield and lending
and whatever is create bubbles without precedents. This is the new enemy. The bubbles are the new enemy. There's a change in the rules of the game,
where effectively central banks are no longer fighting inflation. They're fighting bubbles. In order to prevent those bubbles from imploding,
they'll do whatever it takes, and that is the new degree of freedom. I think the next decade is the transformation
of bubbles that are too big to fail into inflation. This is something that we're starting to see,
in my view, and that will accelerate. RAOUL PAL: What does that inflation look like? Because again, inflation is a different beast
in many ways. For example, I always look at a basket of
27 currencies versus gold and gold goes up, it shows that the basket of currencies is
going down against gold. That's one way of showing it. You don't feel it necessarily because wages
aren't going up and stuff like that. It's because of this monetary devaluing, which
I think is the important thing for people to get their heads around. I don't know. How are you thinking this information is going
to show itself? DIEGO PARRILLA: The first point to understand
is, I'll just emphasize the point I made earlier, is inflation is about the value of money going
down. Now, you can think about that in multiple
dimensions. Many, many. Higher equities are just the way of inflation. You can think obviously about the most obvious
one, which is real assets. It's about the balance of which the speed
at which you're printing money, the currency A versus currency B versus real asset C. In
the case of gold, there is an element of printing because producers do go out and I think the
magic number is I remember 1.6% per annum. Theoretically, if central banks were printing
in that pace, the amount of dollars and the amount of gold would be equal, but the problem
is when this gets tipped off. Inflation has multiple dimensions, but it's
really as simple as that, it's the loss of value in that money. That's why the view that I carry and the thesis
that I carry is it has massive implications for asset allocation. Clearly, in that team as I call it, you want
to have your strikers, your midfielders and your goalkeepers at all times, but your strikers
should be equities, not credit. If in 20 years' time, the hundred euros or
$100 that your corporate bond they're going to give you back are not going to buy you
much at all. Those hundred euros that you're going to get
are not going to buy you much. If you want the striker, somebody that will
do well when the world does well, you want your equity risk, because perhaps the price
of wheat goes up, perhaps the price of bread goes up, but the margin of the baker and the
multiplier applied to that margin will still be there. The equity I think will participate a lot
more than the credit, and that's just a way to-- one of the basic implications that I
see in the portfolio, but there are multiple, multiple ways in which it will impact our
lives. RAOUL PAL: One of the things I was looking
at, I was writing Global Macro Investor over the weekend, and I was using the G4 central
bank balance sheet, and then looking at different denominators. When you look at it in equity terms, equities
have actually done a pretty good job at offsetting the printing. Now with this recent printing, it looks like
it's breaking down. Gold did a pretty good job, but it was slow
off the mark. Then it's done very well. You can definitely see it with certain assets,
the one that did extremely well in this was Bitcoin. It seems to be the only one that actually
outperformed the central bank's balance sheets over time but I think that's really important
for people to understand, the kind of assets you need to own because as you said, credit's
just not going to work in this environment. DIEGO PARRILLA: I think the three-- if you
think about your football team being strikers, midfielders and goalkeepers, I think the strikers
I would personally favor equities versus credit. This is what will work in in a more benign
environment where it's just long inflation or short inflation, basically. On the midfielder side, it's clearly real
assets. By that, I mean things you can't print, and
you can put whatever you want there. I would favor real estate and gold and/or
others but real assets in general, including, many things, and the guy to avoid is cash. Lots of people think about putting their money
in cash, it's okay. Cash is a striker in the bench. You put your money aside, you're waiting for
the opportunity. If you leave your striker in the bench for
three or five years, you will have a problem. The other area to be mindful of is the defenders. On the defender's side, I would argue that
government bonds with this yields already zero or negative in many cases, they have
very, very little defending power. I joke, and I call the bund, Franz Beckenbauer,
it was once upon a time, this fantastic defender, world champions in 1974 but the guy's now
74 years old. The ability for the bund to do any defending
is much more limited today. There, you need to look for the anti-bubbles,
you need to look for things like gold or [?]. RAOUL PAL: Does that mean portfolio construction
overall is going to have to change? You've led the way in doing that by saying
listen, we need a different portfolio construction. The whole industry is still 60/40 and basically,
the 40 is bonds which is cash and some of it, negative yielding. It doesn't cushion anything any longer, it's
just cash. DIEGO PARRILLA: This is super important for
investors to understand and we've grown in this mindset of the 60/40 balance portfolio. What you've seen with this transformation
from risk free interest into interest rate risk is you have effectively parallel bubbles
built both on the fixed income and the equities. You are discounting these cashflows at artificially
low levels, you're multiplying the PEs with equity risk premia, and all this stuff. As we discussed, the government bonds and
fixed income doesn't have that explosiveness unless you think interest rates will go to
minus five, in which case, you're delusional. I just need to look at a couple of numbers
to understand that Germany is more likely to borrow 5 trillion at minus one than 1 trillion
at minus five, already at minus one for 30 years, you will do your size. There are limits to negative interest rates. The implications are huge. This goes into perhaps one of the biggest
risks in the system and something that we emphasize a lot, which is the risk of false
diversification. False diversification stands for this perception
that you're diversified because look, I have a bit of fixed income, a bit of equity, a
bit of credit, a bit of oil, a bit of whatever and it looks like I'm diversified. The reality is when you have a big crisis,
every single piece in the portfolio behaves the same way. It's all one trade. This idea, it's become very relevant. It's a byproduct of monetary and fiscal without
limits. You've already squeezed the orange creating
these bubbles, and no longer you created the bubble, which means your problem is huge,
you actually have no defenders, no conventional defenders. What it means-- and this is really the way
we shake things up with my fund and I think it's not about the correlation, it's not about
being super smart and deciding, it's about playing your position in the pitch, and we
play goalkeeper. We are about 55% in the year with a sortino
close to five, we're the best hedge fund in the world in February, plus 10%, plus 19.1%
in March and then we've been up also in the last quarter. You want to be in a situation where your strikers,
you want them to be call options. You want your strikers, your equity or whatever
to give you that upside but have some limited downside. You want to choose your strikers to be call
options and you want your defenders and goalkeepers to be put options. You want things that will pay you a lot of
money when there's a crisis but they will protect the capital. This is really like in football. Barcelona and Real Madrid and all these teams,
they don't win just because they have Messi right. They win because they have three chances and
they score two and they shoot 10 times, and they only score, they received one. As simple as that, if your strikers do their
job and your goalkeepers do their job, then magic happens because then, you get into rebalancing. This is key. Understanding the risk of false diversification,
understanding what are the true strikers, what are the true goalkeepers and defenders,
and then having the ability to embrace the stupidity of the market. Things like the VIX, as a clear anti-bubble
in the system. The ironic thing, and just as a reminder of
the concept of anti-bubble, which I coined in the book as you know and we've discussed
it in previous interviews, but I think is worth perhaps revisiting. When you think about bubbles, we're talking
about assets that are artificially expensive. They are based on a belief that happens to
be false, it happens to be a misconception. This is Soros view of bubbles. The emperor had no clothes. What I looked at is I said, look, I generalize
the framework of Soros and said misconceptions distort reality. Not only through artificially high valuations,
you could also have artificially low valuations. This concept of anti-bubble means three things. The first one is assets that are grossly artificially
cheap. It means it's a matter of when, not if that
they will go up, they're a form of extreme value. That's number one. The second important dimension is the fact
that bubbles and anti-bubbles are like distorted mirror images of each other. They're effectively two reflections of the
exact same process, it's the same misconception that is driving if you think about a medicine
or any belief. Up and down valuations of assets. By construction, the moment that misconception
is understood and the bubble bursts, is the exact same moment that the anti-bubble reflates
by construction, it's the same process. In fact, it's often the anti-bubble that pricks
the bubble, as we'll see in a second. This idea that gives you a sense of, and this
is why I called it anti-bubble, a bit like an anti-virus, or an anti-missile, is a defense
mechanism against the bubbles. When I said anti-bubble by the way, I swear
I meant more of a computer virus not COVID, but nevertheless, it still worked. The third dimension, which is very important,
and the point I was going to make is that bubbles and antibubbles are feeding on each
other. Think about a S&P and the VIX. I would argue that artificially low volatility
feeds or contributes to artificially high valuations in equities, for example, and it
does it both for qualitative reasons, which is complacency, the perception of low risk,
as well as quantitative reasons such as artificially low vol, creating effectively CPA leverage,
that outdo or correlates and fits into their own trend. Effectively, what you get is the beauty of
risk premia. Nobody wanted to buy puts in the S&P at 3410
vol. Now, well, a few of us, yourself included. Being a contrarian and effectively understanding
the mirror image of this bubble equity and in volatility, effectively, it works wonders. The beauty is that the market is giving you
the cheapest insurance when you need it the most, and that's the moment of most complacency. When you put everything together and you think
about the anti-bubbles, and you think about this dynamic and this portfolio construction,
what we really need to do is look through, okay, what are the beliefs that are false? What are the bubbles we're building? What are the anti-bubbles? What are the rules of the game? In that sense, we don't claim to have a crystal
ball. Oh, equities will collapse or whatever. No. All you know is something has to give. Look at this month. We have a very dire outlook with COVID worsening
in many parts of the world. Earnings, whatever, lots of issues, equities
up 5.6%, and you look at the other side and you see that it's all driven by government
bond yields. It's the only reason, it's all about the risk
premia, it's all about this equity valuation is largely about this distorted value of money. All you know is that if you build a portfolio
that has bubbles and anti-bubbles, you're going to be much more balanced, because you
are effectively building something that is going to behave in a given way by construction
rather than relying on asset class diversification, which is completely gone. RAOUL PAL: One of the issues with this, when
people start to-- and we'll go into how you construct some of this. Generally speaking, people think of this as
like a long vol structure, most of those long vol structures bleed cash, so people are out
of business, and then they suddenly make good in a short period of time, how do you build
a portfolio that doesn't do that? How do you get it so it does okay in good
times, but then really acts as the anti-bubble in bad times? How do you do that? DIEGO PARRILLA: First of all, very important
considerations and when we've built the strategy, we have pretty ambitious targets which is
capital preservation first, it's first and foremost. Second, as a goalkeeper, you want to create
very big positive returns when the clients need it, when things go wrong. Then you want to do that with neutral to positive
carry and expectancy. Now, to your point on many of the volatility
funds, one of my criticisms of some of the use of volatility funds is that they're often
U-type of payoffs. They're basically telling you, hey, if the
market is down 20%, I'll make you a ton of money. If the market's up 20%, I'll make you a ton
of money. My question to them is your strikers are making
you a ton of money when the market's up 20%. Our job as goalkeepers is to give left tail
protection. It's not right tail. The problem is that if you're actually trying
to catch both sides, I will catch you the minus 20, I'll catch you the plus 20, you
may not catch any plus you may be bleeding way more than you need. It's a different game. I'm not saying it's better or worse is different. Now, the second comment I would make is we
are long options. In fact, we're not necessarily-- we have to
differentiate between long options and long volatility. This is a very important concept and I could
give you- - there's two main schools of thought in options trading and we, in my strategy,
effectively one of the things we've done is we're long things like gold or treasuries,
but we have an option portfolio. One of the things that makes us apart, stands
apart is that we only buy options. When you buy an option, and you can only buy
options, there's a lot of good things that happen. The first one is with 100% certainty you know
your downside. If I spent 1% premium in an S&P put, and I'm
wrong, I lost my 1%. When I was Global Head on the commodity side,
I've seen a guy with $1 million of bar, lose 50. A lot of these things happen in every crisis,
there's lots of things that you could see. A lot of these blow ups, and I'm elaborating
with some of the problems with conventional defenders, is of course leverage. Don't get me started with leverage gold miners
and the JNUG and what happened in March where a good idea to turned out into a terrible
outcome because of leverage. Today, the miners are up significantly but
the leverage plays worth still a few cents on the dollar. It's really about a hidden short vol, also
beyond the obvious leverage is about hidden volatility and hidden correlations, and how
these things effectively behave in a crisis. You could see the typical case. I know everybody loves Tesla on this channel,
too. You could say, look, Tesla is a terrible asset. I'm going to buy puts on Tesla, and I'm going
to finance those puts by selling calls. My point to them as a risk manager is, dude,
you're not financing anything. You're long puts, you're short calls and if
you did it on a leveraged basis, then this thing just went up, you are out. This is, if you just bought your puts and
Tesla and you were wrong, okay, I lost my premium. If you naively were caught into financing
those positions, effectively within leverage basis, you're bankrupt. It's very important to understand what not
to do and how not to blow up, and these are very well-known recipes such as no leverage,
hidden volatility, hidden correlation and things like artificial [?]. What we do is
first and foremost, we only buy options. You might argue, wow, that's very restrictive,
how much are you bleeding? Then I would give you again an example. There are two big schools of trading in options,
what I would call the Black and Scholes boys and girls, and the Monte Carlo boys and girls. Let's think about how these two options operate. The Monte Carlo boys and girls think about
options and the premium represents effectively the tradeoff between time value, your theta,
and gamma, how much you make by playing the delta neutral position. It's about implied versus realized volatility. It's about the path dependency of the payoff. I could give you a very simple example. You buy puts on the S&P for one month, you
spend whatever, 1%, and then you as a Black and Scholes person, you tell me, Diego, I
want you to trade the S&P vol. Let's say that, well, you're telling me I
want you to trade the vol, I don't want you to be directional. Like, okay, fine. I'll delta hedge it. I have my put, I delta hedge it. Let's assume for the sake of argument that
the market goes down 1% every day for the next one month. You as a black and Scholes guy, market goes
down, you have a bit of gamma, you buy a little bit of the market and you buy, buy, buy. After a few days, there's probably not a lot
of gamma left. You did not have a single chance in the entire
month to sell back the gamma that you bought. The realized volatility of a straight line
is zero and turns out that potentially, you could have even flattened out or even lost
money. You come to me and say, Diego, the S&P is
down 25% in the month, you're a vol guy, and the reality is, well, I bought it at x percent
implied, it realized zero. Yes, I had some gamma, but it's possible that
I even lost money. Now, this is the Black and Scholes world,
it's the market makers, and it's the way the market operates. It thinks about this way. The other way to think about options is more
like Monte Carlo. This is, those who are familiar with the method,
is Monte Carlo the casino. You basically look at 100,000 iterations of
what the price could do based on your implied volatility and correlation and forwards on
whatever. Then you look at the expected value of your
option. In this case, the put on the S&P and surprise,
surprise, magic happens. Ex-ante, Black and Scholes and Monte Carlo
will give you the exact same valuation. The expected tradeoff of this theta and this
gamma, it's exactly the same as the expected value of the option. There's a big difference. If I bought that put option, and I went on
holiday for a month, and I came back and I asked what happened in the market, and the
market is down 25%, you made 25 times your money. When you think about the market as a Monte
Carlo person, you think about premiums, you don't necessarily think so much about volatility. Thinking about premium is very important. If you're playing long dated FX forwards,
for example, you could see such a massive interest rate differential and in such a position
that when you apply the forward to the vol, to the skew, effectively, you have multiple
ways in which you would get the same price subject to different variables. Volatility means less and in fact, you have
incredible opportunities to buy artificially cheap optionality. You could find-- and what I'm going to say
sounds a bit shocking to some people, even to some professional options traders, but
it is perfectly possible to buy options that are cheap, the three things we'll look for,
cheap that have very explosive payout, five to one, 10 to one, 20 to one and that are
actually neutral or even positive carry. Of course, it's not that obvious. You might need to look for certain things,
and this comes sometimes in vanilla form, with big [?] forwards. RAOUL PAL: FX forwards were great for a while. DIEGO PARRILLA: It's a very good example,
long dated, and things. Then you have also more exotic payouts and
correlation plays. This is something that, for the sake of argument,
we can show people. Let's think about, I'm the goalkeeper, so
my view is I want to be things that are, for example, we could bet on gold higher or S&P
lower. Let's take just a case study here briefly
to see what would we do and you could do vanilla option or we could do what is called a digital
option, something very simple, black or white, heads or tails, yes or no. Let's start with gold. If you'd have the spot price, you take your
forward. If you bet market lower, higher lower than
the forward. That's roughly 50/50. That's roughly two to one. In a very low vol environment, if you go a
little bit further out, and you say, well, what are the odds of gold being in one year,
5% or higher? Obviously, it's not 50%, it's less because
the market needs to go up. For the sake of argument, let's say that that's
three to one. Whatever, it depends on the volatility, the
lower the volatility, the bigger the payout, the higher the volatility, the farther out
you need to go. RAOUL PAL: And the time, volatility and time. DIEGO PARRILLA: And time, and time. Let's say-- and these are real numbers, more
or less one year, 5% out, it was three to one. It would have worked well, whatever. Now, you could do something similar on the
S&P, you could say well, S&P higher or lower, 50/50, two to one, 50 cents, we'll pay you
$1. If you go farther out of the money, and you
go a little bit farther out, then obviously the put skew is going against you, but let's
say for the sake of argument that you could also get a three to one with 5% moves. You and I could choose and say, hey, Raoul,
would you rather buy three to one gold up 5% or three to one S&P down 5%? Who knows? Perhaps we like one, perhaps we like the other,
perhaps we like both. Now the question for you is, how about both? How about gold up, S&P down at the same time? Here, the market needs to figure out the implied
correlation. What happens and what's driving things there? One of the things that the market has been
doing lately is there's been a lot of demand as an inflation play and correctly for now,
for gold higher, S&P higher. The market is demanding and doing the right
products. I'm happy to take, let's say the other side,
I might say, look, I actually believe gold higher and S&P lowers as a goalkeeper. Assuming zero correlation, or even things
have been priced in slightly in our favor, here, the two events are considered uncorrelated
so you could do that at 10 to one, so roughly nine to one, but you get a little bit of a
pickup. Now, you're risking, let's say, $1 to either
lose it or to make 10. The idea here is that perhaps some of these
bets are the same bet. A scenario of gold is flying might well be
because there's trouble and even rate's lower don't fix it. When you create and you find all the tools
available you look at forward skews, time, implied correlations, equity higher, dollar
higher, we did things during the crisis that was accumulating this stuff. You know who the defenders are, you know who
the conventional guys are. It's gold higher, treasuries higher, dollar
higher, VIX higher. You know who the guys are going to be under
pressures is equities, is credit, is high yield, is commodities, commodity currencies. How do you use your budget of options to buy
these bets in the most diversified and effective way possible? Right now, of 550 million of assets under
management in this strategy, we have a lot of these small bests placed, and then you
benefit from things like equities down, dollar up. By buying these things at 90% discount to
vanilla, boom, these things could be very, very explosive. At the end of the day-- RAOUL PAL: Isn't that
a bloody difficult portfolio to run. Because you've got tons of implied correlation,
bets, probabilities, and yes, you have some structural framework in your head, but it's
not an easy portfolio to run. Because you have so many moving parts. DIEGO PARRILLA: If you were delta hedging
this, it would be impossible. You can do it. You can do it. You would blow up. The beauty of this is that I only buy these
options and I'd size these options, my average bet is 50 basis points. RAOUL PAL: What time horizon is your general
option structure? DIEGO PARRILLA: I have one option that is
30 years just to give you a sense, but here, it's about finding the right balance between
puts on bubbles, calls on anti- bubbles, finding the right mix of maturities, finding the right
mix of underlyings and stuff, so I have budgets. I have, for the balance of 2020, I have 5%
at risk. That's it. With 100% certainty, you're telling me, Diego,
it's bloody difficult to manage. No. With 100% certainty that 5% in options I bought
in 2020 cannot lose more than 20%. What's hard to manage about that? Nothing. RAOUL PAL: Let's say you close an option,
you'll just re-spend that risk bucket with a maximum of 5%. You may not choose to do all of it. Let's say an option you have goes up and now,
it's gone up to 3% of nav, you trade it back down to 50 basis points. DIEGO PARRILLA: For example, VIX. Fascinating trade. We talked about the VIX earlier and people
are saying, Diego, come on. The VIX is mean reverting, is negative carry,
it's impossible. Well, guess what? The VIX at the end of February was breaking
40. We have it 40, 45, 50. The market is indeed very used to thinking
that the VIX is first of all, every single spike in the VIX what's sold aggressively. It's mean reverting and stuff. The second thing the market was telling you
is this is going to be very short lived. Now, you and I have been looking at the virus
and many others and could realize that this is not something that's going to go quickly. This is going to be a while. Now, your front contract in the VIX was trading
45, 50. May and June., we're trading at 27. We're talking about call it rough numbers. 50 in the front, and two contracts out, you
had 27 and 25 on a forward basis, you could buy the future 25 for June, when the spot
was at 50, so you had massive backwardation on the expectation the market was going to
collapse. From a vol perspective, you have the front
trading at 150, 175 vol and you had the deferred contracts just two, three months out trading
at 75 vol, so half the forward, half the vol. What it meant is you could buy a $40 call,
which we did, with effectively positive carry because if things stayed at 40 to 50, you
were long at 40 for less than $2. You have a low premium, but that was my worst
case scenario, if the market was to effectively roll and stays at 45, 50, you would potentially
make five times your money, just purely on a roll basis and if, as it was the case in
our view, the VIX would spike higher then you're sitting in this thing. Now, that money that we spent, I had about
in dollar numbers about 3 million of premium, effectively, we like to exit in stages. You exit in one third, you exit in two thirds,
you exit in full, so by the time you sold one third of the position, you already paid
for the entire option and more so you're playing with free money. We averaged those 3 million, I think we sold
out for about 22 million. As we said, that money-- at that point with
the VIX at 80, opportunity in the VIX is not there any longer, but you look to the right
and you see gold has collapsed. You see the Chinese yuan is looking very strong,
and you look at certain pockets of volatility. My job is to redeploy-- to have a portfolio
of goalkeepers, these things, some of them play, some of them don't play but when they
play, and you monetize them, profits become capital. That capital becomes, in our case, gold, it
becomes treasures and becomes new options and those options are forward looking. This is where people were a bit shocked at
the beginning. It's like, okay guys, you're up 45% in the
first quarter, and then April came in. We have the highest one month moving S&P since
1987 and everybody was expecting a bloodbath. We were up 1.2. Then May come in, and we're up 5%. I was like, what's going on? The answer is, look, you are playing this
process. Even within the options, there are opportunities. Not every single asset moves synchronously. March was a great example. We have effectively the first leg of the move,
as you remember, was volatility going up and funding currencies and funding trades, so
Aussie/yen, vanished. It went boom. Dollar/yen goes from 109 to 101. The Aussie goes from 70 to 58 cents or something,
like crazy move. That was because-- the rally in the yen didn't
happen because necessarily people were-- they love Japan or the currency, it's like, okay,
dude, I'm funding myself in a position I have carry. I've been making all these little money and
then boom, they get taken out. Now, the next move with vol, and then the
third week, you have gold and treasuries collapsing. Big time. Then you have the VIX flying. Having the right portfolio of goalkeepers
truly diversified, it'd be pointless if I told you that all the 50 options or whatever
I own are the same thing. In fact, we are actually long gold and the
dollar and some of the trades that we do, and this is beauty, gold up, dollar up. When you think about the market, and you--
RAOUL PAL: That correlation bet was one that I've looked at for several years, fantastically
cheap because it shouldn't happen. DIEGO PARRILLA: It shouldn't happen and these
things change, but correlation is bipolar, very often it just goes. What this options allow you to do is things
like if you ask the market, like the gold and S&P trade. You go and say hey, gold higher, it gives
you the odds, whatever. You say, okay, what are the odds? What happens to the Euro if gold is at 3000? The mathematical model will say come on, Diego,
easy, Eurodollar, gold at 3000, 170. The model is wired to think that if gold up,
dollar down, therefore it thinks gold up, Euro up or yen up or Swiss franc or whatever
it is. Effectively when you combine these pieces,
it doesn't mean it works all the time or for every single thing is easy. There's a lot of science in this process,
but when you play options, and you have the ability and the tools like you have, we've
talked about this many, many times in different capacities, you have the ability to actually
decompose these probabilities and understand not only single asset but conditional probabilities,
what you're able to do is effectively achieve our objectives which is reduce the premium,
increase the payout multiple and reduce the carry. Because if you think about the gold versus
S&P trade, for example, that we discussed earlier, if you buy the dual digital or worst
of whatever, if one of the legs works well, in this case, it's been gold, and let's take
it to an extreme, that trade that we bought at 10 to one, gold goes to 3000. That condition is met, gold is higher now. What you're left is a vanilla put on the S&P,
which you bought at one third of the price of a vanilla. You can see how you can actually play with
carry and you can actually do things by basically creating a framework of-- as options specialist--
RAOUL PAL: I love that thought process of looking at things where there's an embedded
assumption that everybody believes to be true that isn't right. The one that I always fixate on is dollar/yen. The market has a total belief that dollar/yen
is a risk asset, that the yen goes up every time is risk. Now, my guess is there is a set of circumstances
which may be even playing out in Japan as we speak, which is it's now got a full second
wave of virus. There is huge monetary printing that probably
needs to be done by Japan to save their own economy and maybe dollar/yen becomes a risk
of asset. Now, the correlation bets in that, because
it's so in people's heads-- DIEGO PARRILLA: It's beautiful. It works really well. It works really well. RAOUL PAL: The funding, because of the forwards
as well, the 3-year options on dollar/yen, virtually thrown away free, isn't it? DIEGO PARRILLA: First of all, I agree with
your view, I think dollar/yen is bad money disguised as good money. I think this belief will change. Then you also have another thing that I like
about it, which is China. I think the yuan is-- China is the biggest
bubble in financial history to put it mildly. When that goes, it's obviously going to go
through the yuan. That's the degree of freedom in the system. In some way, if that happens, you actually
know that Japan will get a first move, but then Japan needs to devalue and compete. I think it will fold for its own way, they
could happen for different reasons, there could be different catalysts, but when you
think about correlation versus gold, it works beautifully. There are ways in which we might be right
or wrong, but all we know is that we buy very cheap options. That's what we strive to do. You buy very cheap options that are potentially
very explosive and have good carry and this is the reason why we have a Sortino 5. What is a Sortino 5? I think this is-- the crowd here is quite
technical so I think we can elevate the dialogue a bit. When you think about a strategy, and how good
are you as a manager, and people start looking at certain things. The first and most obvious is absolute return. Okay, my strategy is up 30% per annum. Okay, that's good. Okay, well done, mate. Fine. Okay. Now, the second thing is, how volatile are
you? This is one slight misconception in the industry. Would you rather invest in someone that has
20% return with 20 vol, or 20% return with 10 vol? What would be roughly an information ratio
or a Sharpe ratio of one or two. It's pretty obvious that with this information
only, you would say, come on, I'll give myself to the Sharpe ratio two, it's higher quality
return. The return per unit of volatility is higher. What's implicitly in this assumption, in this
conclusion is that volatility is bad. RAOUL PAL: Volatility downside and then upside. DIEGO PARRILLA: Exactly. I'm penalizing you because you are volatile. I don't like that. I rather not have that. There are two problems with that. The first one is there's lots of strategies
that have very unstable volatility and correlation, so you could see someone that is selling tail
that looks very nice, very good returns, very low vol and then boom, they implode. RAOUL PAL: The other guy that I remember this
from, I don't know if you remember him, was Roditi, Nick Roditi. Roditi ran the quant portfolio of Soros and
he was easily the best performer at Soros, beat Stan, beat everybody, but his vol was
different. He was like an 18 vol guy. Everyone's like, oh my God, but 18 vote for
him was-- when he was bad, he'd lose 30%. When he was good, he'd make 300%. It's like there's massive skew in his volatility,
so George was like, just do whatever you want. Just keep doing it. I figured that you won't be big enough to
blow up the entire fund, but if you make money, we're going to make enough money. DIEGO PARRILLA: This is the way we think it
and we do it in a way that that downside volatility, downside, you want to cap it. You want to know how much you have. In my case, the explosiveness comes from the
options. There, you can sleep at night at your downsides
there. What you get is exactly the point that you
made. It's not really about average, if the distribution
was symmetrical, then average volatility would be a good proxy for risk, but many distributions
are not symmetrical. In some cases, like ours, we have massive
skew of positive, some people have hidden negative skew, so you want to avoid that. When you actually think about the correlation,
exactly the point that you made, look, nobody called me to complain when were up 16 and
a half in August or 10 in Feb, or 19.1 in March. Volatility in itself is not bad. It's the drawdown volatility, it's the negative
volatility that's bad. When you look at the return per unit of negative
volatility, which is the sortino, that's when you see the asymmetry and where we've been
scoring close to five. For football equivalent terms, you've scored
five goals for every opportunity that the other team has created. It's very difficult to lose a match when you
score five goals with that profile. I think this what it shows you is this obsession--
RAOUL PAL: Is that sortino stable over time, or is it observable in these current markets,
which are more volatile, even not just the headline level, but within sub, whether it's
subsectors or within assets? How stable is this sortino? DIEGO PARRILLA: It's a realized number, so
obviously, obviously, you're looking at-- you have to do it on a realized basis. You say, I made 30% per annum. I did with x percent downward volatility,
six and a half or whatever, and that's what gives you this sortino. Of course, it will change through time and
you might have different dynamics, but in my case, the stability of that is to what
extent, where is that five coming from? It comes from buying, effectively, insurance
that is grossly artificially cheap, in our humble opinion. As you said, there might be long periods of
time where you bought the right thing, you bought it artificially cheap, it didn't pay
out, but eventually, you're still in the game and you're able to realize this, so probabilities
eventually catch up, and you have to stay very, very focused on this process. RAOUL PAL: To get back to how do you stay
in the game, how you explained it to me is you only have 5% of nav risk. Even if it turns to zero-- DIEGO PARRILLA:
For 2020, yeah. RAOUL PAL: Yeah, for 2020. DIEGO PARRILLA: In the options, yes. RAOUL PAL: In the options, so therefore, even
if nothing happens, everything stops, you just lose the premium, you're down 5% in that
part of the portfolio, and that's it. DIEGO PARRILLA: Theoretically, yes, except
that some options, that's your worst case scenario. It doesn't mean that that's what will happen
if you stay here. If you stay here, there are certain options
that might be positive carry. In our case, this is like, look, for us to
lose in every single thing, you would need a gold to go up and gold to go down, or Europe
to go up and Europe to go down. It's like, well, maybe one of them will happen,
maybe not, because you have a diversified portfolio. My point is, you want to live in a world where
you, from a risk management perspective, we self-imposed the long only option for multiple
reasons. One of them is this fallacy of finance. Okay, we want to sleep at night. We want our investors to do that and it brings
discipline. Trust me, because you really need to see where
you spend this optionality. Then you find the right opportunities with
the right premium [?] carry and exit. RAOUL PAL: I think how you're going to think
about buying these options is different to how most people, most people draw a few trend
lines, have a view and so I think the S&P is going to 3500 over the next three months,
buy calls. You're not looking at it that way at all really,
are you? DIEGO PARRILLA: I'm the goalkeeper. You basically told us look, Diego-- and this
is the point I was making with some other volatility funds. I need you in my portfolio to do saves when
things go wrong. We have a correlation of minus one to risk
assets. Every single time that the S&P went down,
and we can look at October 2018, December, May, August, every single time, we made money
and we made a lot of money. This is not something you achieve because
you're smart or because you're clever, or because you have a crystal ball, you do it
because it's your mandate. My mandate is protect the capital, make a
lot of money in a crisis and try to preserve, to do it with neutral to positive carry, that's
the mandate. When we think about these opportunities, we
think about a certain-- there are certain suspects, usual suspects, the first decision
we need to make is, do we spend our money in buying puts on risk assets or calls-- let's
say puts on bubbles or calls on anti-bubbles? That's level one type of discussion in terms
of how do we allocate this? The reality is not my job necessarily to have
a-- I can have a view on that but the answer is I will have both. We'll have some puts, and we'll have some
on S&P and we have some calls from gold or the VIX or the treasuries. The question is, what's the tenor? What are the strikes? How do we combine them? Our job and the reason we perform systematically
during those events is because we know, you know what happens to S&P in a crisis. You know what happens to the VIX. Gold is more tricky, maybe surprises, maybe
not. In fact, we like that because it might be
giving you a different type of hedge under different things. Going back to the discussion of bubble versus
anti-bubble, it's not about ratios. It's not about numbers, it's about beliefs. If you want to find the bubble, tell me the
belief. In Spain, it was like [?], bricks never fall,
it's like there was this mindset and there was very-- if you talk to people, it's like
oh, house price will be higher, like, people looked at you, and like and they said, Diego,
in Spanish, bricks never fall, and I was like, well until they fall in your head. Of course, they can fall but it's very often,
this mindset that, in that sense as a goalkeeper, we know our job. This is very important because when you build
a team, in fact, there are a bunch of people that are positioning themselves as uncorrelated
slash defenders, and I'm going to pick on the CTAs as an example. Yes, they did well in 2008. That was a very different match. If you go back to the football team, and you
ask, hey, what position do you play, Mr. CTA, and the reality is you have someone there
that is, look, when we attack front row, all in, trying to squirrel the goals, so equities
up. You have a guy that is max long, probably
on a levered basis, but that lowest level of volatility. He's max long, how can that max long levered
position in equities be defended? It's not. The idea is when the other team counterattacks,
when volatility goes and is forced to run and defend, you're telling the guy that is
trying to score the goals to run really fast, put the gloves, do the saves, and then go--
and this is what some of the CTAs have been caught. This is why they're getting destroyed. They were max long going into Q4 2018. The market collapses, volatility explodes,
they go short, only to buy it back through the entire 2019 and go max long again, only
to throw it all again and then back in. When you think about a defender, it's a point
to one of the questions you were asking, it's about behavior. It's about portfolio construction. You don't say I'm a defender because I did
well in the previous crisis and many macro guys are poker players. I'm more of a chess player. I play more medium to longer term. I'm not looking for the next move in gold
or our investors know that we have gold, treasuries and options. RAOUL PAL: Yeah, I want to talk to bit about
that bet, just as we wrap up. I think you got a great idea of how you look
at options and it's not about looking for the next move, you're looking for the cheap
bet, you're creating a value portfolio of options that give you outsized returns if
you get it right or low losses if you don't, and you just build that bet repeatedly. What's the rest of the portfolio? Because if it's 5% be the risk with that,
what's the 95%? DIEGO PARRILLA: We have about-- so our portfolio
currently, the strategy, which is a use of strategy, it's about 50% in gold, and precious
metals, about 25%-- RAOUL PAL: Is that straight precious metals or miners as well? DIEGO PARRILLA: We have the flexibility to
shift but it's primarily gold, so call it 70% of that piece will always be gold, but
we have the ability to go into silver, platinum, palladium, miners, whatever, but it's a minor
piece. The core view is on gold. This we buy without leverage so it's a core
long position and we tend to add puts ideally. The idea is to run a rolling synthetic gold
profile, which effectively gives you the known upside if you are top-ish and you buy the
puts, as the market goes down, you monetize the put, buy more gold, it's a rolling synthetic
call. We run a similar piece, similar strategy in
in US Treasuries for about 25% of our portfolio, which I'm going to discuss because it's very
important. It touches on one of the misconceptions in
the system, and there's about 20% to 25% in options. The 5% I mentioned was 2020, we have a bucket
that is another 5%, 7% in 2021, 2022 and [?] that go all the way to 2030. That 20% to 25% on 10 to one options could
make you 200%, 300%. This is why we're so explosive. Let's look at the treasuries for a second. They're all defenders, gold, treasuries. Now, our view on the treasuries bucket, again,
no leverage. The neutral position would be 10 years, but
we have the ability to change duration. One of the things we've done is we have a
non-consensus view of zero interest rates and higher inflation. This shocks a lot of people, they say, Diego,
what are you talking about? Look, the rules of the game say that if inflation
comes in, interest rates are going to go up and bonds go down. My point is no, the rules of the game have
changed. Because if you hike in interest rates, it's
science fiction. It's not going to happen because the whole
system collapses. You're working on the basis that you cannot
hike interest rates, and that inflation is the answer to some of this exit. For example, we have a meaningful part of
that Treasury component into 300-year TIPS. You have some reasonable amount of yield to
pick up, it's tiny relative to where it was, but it's still 1.2% times 30 years, that's
a meaningful upside. We have potentially risk overshooting on the
inflation side so about half of that Treasury position is in 30-year TIPS and then the other
half is in nominal treasuries between five and 30s but we play that duration without
leverage, and again thinking of as a defender, but on the option bucket, that 30-year that
I mentioned, it's a synthetic way have been very, very long 30-year treasuries. We bought through a very interesting relative
value trade, you look to play that in option format. Everything we can do an option format, we
will do an option format. You don't need to take as much delta one or
linear risk if you can find the way in options, so that's the idea. We have this conventional defenders, primarily
gold, 50%. My book was called, Opportunities Heading
into Lehman Squared and Gold's Perfect Storm, three to 5000 gold in the next three to five
years. That article that I published in the front
page of the FT, I still have that view, it's been reinforced. I think Treasury yields might go to zero and
you will have inflation. I think as we discussed, gold and treasuries
may not be sufficient on their own as defenders, you need to find that asymmetry in the portfolio
which you're not going to get from the conventional defenders, and the answer is options and ideally,
something that is-- RAOUL PAL: One day, you'll realize that the answer is Bitcoin, but we'll
have to get you there first. DIEGO PARRILLA: What I'm going to say-- RAOUL
PAL: It has the most optionality in your terms. Even if it's wrong, the optionality is so
good. DIEGO PARRILLA: The biggest factor in all
my analyses, the biggest bullish reason in Bitcoin is the fact that you and a couple
of very smart guys are bullish. I go in how you think, I'm a little bit more
skeptical. RAOUL PAL: Read the book, The Bitcoin Standard,
the Saifedean Ammous book, Bitcoin Standard, because it'll talk to you because it basically
talks about the gold standard, and why Bitcoin could be perceived to be a superior version
of that. Even if you don't believe it's superior, you'll
understand the optionality once you read it. DIEGO PARRILLA: I think Paul Tudor Jones'
newsletter was also very telling and I love the way he thought about it, talking about
the fastest horse. I think you guys are spot on, and there's
going to be a phase in this process where Bitcoin's going to be the fastest horse and
we're now in a phase-- and I think it's true for gold. Many people might be telling, they're thinking
right now, Diego, come on. We're at historical highs in dollars, by the
way, in every other currency, we made it long before. What's next? Do we have retracements? Look, this is a whole new game. Gold is just a number. There are multiple ways you could think about
the value. I know it sounded crazy when I was talking
about 3000 in gold when it was a 1200, but now, I'm conservative, I'm almost left behind. Once you get into certain price levels, this
becomes very exponential and I have no doubt that Bitcoin is and could be one of the most
asymmetric asset classes. I defer to you for the-- and very smart guys
for the rationale-- RAOUL PAL: Bitcoin and gold, all for the same reasons. Let's cut forward, three years. Let's assume we are in an accelerated phase
of bad shit happening, and the central banks are fighting as we expect them to do doing
what we imagine, same with governments and gold is now at 3500. What next? What is the next phase of this because you've
had captured that phase, and in that environment, you'll have done very well. Once you get to that and the system is now
at the point of change, what the next iteration? DIEGO PARRILLA: I think when we design these
solution strategies, there's a temptation to think certain asset classes have done their
job, and that's it. You could think about rightly so, about bunds. Bunds completely lost their use or their value,
is there any value left in bunds? The answer is, well, I think they will continue
to be a core allocation and part of many insurance and many portfolios. There's going to be situations where perhaps
there's risk of selloff with inflation scares and whatever happens. It's almost like the first phase is not easy
money in any way, but certainly from very artificially low prices to more normal. Then you will have, I think there's still
be a role to play, and we will see what it means and I think here as part of the team
and the portfolio, that true diversification comes from having lines that some will be
green, some lines will be red, but that's where the diversification comes. I think from here to 3K, it's going to be
perhaps faster, or could be more explosive. You have no clear references technically,
and it's just a number, worn in because the drawdown is going to be brutal when it happens,
so you might get people who felt they've missed out at 3000 will all be talking about 10,000
gold and then you will maybe go back to 2000 in one day. Who knows? Who knows? This is what we're getting into. If you're levered, you're dead. Dead, which means you should favor options
or non-levered ways or other ways to play about this and do it in a portfolio context. I think, look, my vision and this chess game
that has been reinforced, has many variables. It's going to create, I think, a very special
polarized outcome. There are some clear winners, there are some
clear losers, EM is going to be brutal in certain pockets, certain aspects of credit,
then depending on how bad it is and how systemic and whether they decide to bail it out, that
will transfer the problem back to more inflation. It's going to go-- something's going to give. I don't have a crystal ball, all I know is
that a scenario for example, as this strategy has been doing. I might be long puts on the S&P and calls
on gold, but if both go up, you net-net make money and then if the market decides to change
its mind-- RAOUL PAL: You get a free option. DIEGO PARRILLA: Maybe you get the downside. In that sense, I think it's important to when
you think about building the portfolio, do something that is balanced, and that requires
thinking in terms of inflation, in real terms more than nominal. We discussed that earlier. Then you need to decide what the right weightings
are. Howard Marks, someone emailed me one of his
newsletters and with a joke, it was like, it looks like he read your book. I guess he was basically talking about, he
said, look for decades-- he said something along the lines of for decades, I've been
effectively looking to optimize between equity versus credit, developed market versus emerging
market, growth versus value. All this dynamic which is really all about
the strikers. It's a striker mentality. It's the mindset of just position your strikers
and he said something, look, I think the next few years, the important balance is offense
and defense. This is the new balance you need to find,
because if you don't find the right balance between offense and defense, then your strikers
won't matter. If you don't have a goalkeeper, then who cares
whether your strikers are more on the left or the right. I think in that sense, it's very important
for people to know understand their own risk. Many of them are strikers, maybe many of them
lost their jobs and their wealth in this crisis. You might be a striker to start with, then
how do you want that team to work and look for true diversification, delegate to the
right people those pieces and enjoy the stability of the market, enjoy the volatility with rebalancing. It's incredibly powerful. A portfolio of 80/80 [?] S&P, rebalance monthly,
just the rebalancing, just this idea that, oh, the S&P is now 3400. Now, it's 2200. Now, it's back to 3250. Just going back to your neutral weight would
have made an incremental 10% return. Instead of trying to pick the tops and the
bottoms and fight between bulls and bears and stuff, I believe in the team, and in that
team, I don't pretend to be everything for everybody, I don't think it's the answer. It's you need to understand which position
you're playing. That's all you need to deliver to the investors. This is by the way, the number one feedback
I've received from the big investors, is you've done what it says in the tent. I think this is really going back to the points
we've discussed during this conversation, which is delivering that portfolio construction,
understanding those risks of the challenges posed by the abuse of monetary and fiscal,
the implications of false diversification and portfolio construction, and how we need
to adapt to a new decade which will be in my view very different from the previous one,
with different challenges and different opportunities. Certainly, it's not about being bullish or
bearish. It's about having the right team for the American
guys. It's not about Michael Jordan as a bull or
Singletary as a bear, it's about having a team with both and rebalancing them. That way, I think it's way more powerful and
way less stressful than just pretending that this is about having a crystal ball, because
it's not. RAOUL PAL: Diego, fascinating. I think a lot of people-- there's a lot of
people are going to be taking notes on this, trying to figure out how do I apply any of
what I've learned here. I think really interesting, I think it's super
valid what you're doing in this environment particularly. I don't see any other way of navigating it,
but it's not easy. Hats off to you for doing so well in a very
complicated world. Having seen it, again, like the Energy World
is Flat, having seen this world in advance in a cohesive strategy that was capturable
was really good. I wish you the best as ever, and I look forward
to catching up again soon to find out more from what the hell's going on. DIEGO PARRILLA: It's been my pleasure. I thank you so much for the opportunity to
share the thoughts, it's been great. I wish everybody lots of health, most importantly,
and we'll be in touch. Thank you again. RAOUL PAL: Yeah, perfect. Thanks, Diego. DIEGO PARRILLA: Thank you so much. Bye. JUSTINE UNDERHILL: If you're ready to go beyond
the Interview, make sure you visit realvision.com where you can try Real Vision Plus for 30
days for just $1. We'll see you next time right here on Real
Vision.
He is absolutely correct. 60/40 is vastly inferior to a derivative hedged portfolio- especially during the era of "Twin Bubbles" as he talked about. During the Feb sell off, the desk saw cross asset vol and correlations explode. Liquidity completely dried up in the fixed income market (even in govt issues) and we had a twin sell off. It was brutal. That finally put the nail in the coffin for me that 60/40 is a dinosaur's way to invest (don't tell this to /r/investing though).
Pro tip - if someone calls their video a "masterclass" they are a bullshit artist par excellence.
Pimco announced they're dropping the 60/40 model a couple of months back. Pal is pushing the Bitcoin pretty hard. At least he's mannered about it unlike charlatan Max Keiser who uses his RT show to exploit the naive.
What were the takeaways from the impact of ECB or Abenomics on retail investors? Agreed that a ZIRP or NIRP complicates classical portfolio mgmt.
I’m sure that derivative hedging is great if you’re saavy - otherwise, it seems most investors benefit by simply reducing bonds as a % share of their portfolio. Bloomberg reported that 60/40 portfolios performed well into this year’s black swan event.
https://www.bloomberg.com/news/articles/2020-11-22/the-60-40-portfolio-is-muzzling-critics-with-another-big-year
Edit: typo removed
It's a fascinating discussion and the death of balanced portfolio makes sense with where interests rates are and look to be over the next 3-5 years, however for all the discussion of his alternate strategy I can't find a single fund on Quadrica's site that has any upside in the last 4 years. Where are all these fantastical returns Diego is discussing? We've been in an uber bull market for a decade.
Their best performing funds are flat over the last 4 years and many of them negative.
http://www.quadrigafunds.com/
edit: typo
60/40 has been outdated for decades. It’s a myth to fool amateurs
That guy can't communicate.
INCREDIBLY insightful explanation regarding the increasing irrelevance of 60/40 portfolio construction, in the new paradigm of negative interest rates and QE infinite