John Stepek talks to Dylan Grice, co-founder of Calderwood Capital, about inflation, duration and the “death” of value.
In the wake of the 2008 financial crisis, Dylan Grice gained a reputation as one of the investment industry’s most consistently interesting and provocative analysts, working alongside Albert Edwards as a strategist at Societe Generale. In 2013 he moved to Switzerland and spent several years working with Calibrium, a family office. He is now coming back to the UK to launch Calderwood Capital, a new hedge fund and research service (including the return of his “Popular Delusions” newsletter). He’s also coming to the MoneyWeek Wealth Summit next month, so I had a quick catch up with him over the phone last week.
Given his focus on “macro”, my first question had to be about the financial crisis, and the fact that, a decade on, it feels as though we are still waiting for some sort of ending to draw a line under it all. “I’m not sure there is ever a cathartic event that fixes everything – certainly not one that people recognise at the time,” he says. “The nature of the world is that you go from one unsustainable situation to another – when you get right down to it, that’s the second law of thermodynamics!” However, the fact that trillions of dollars worth of government bonds trade on negative yields “doesn’t make a whole lot of sense – and the desire for inflation and stimulus appears to be a risk point for the undoing of this bull market in duration”.
The return of inflation
By “duration”, Grice means any assets that are particularly sensitive to moves in interest rates – so not only long-term bonds, but also illiquid assets (such as private equity) and stocks whose focus is all on growth rather than profits. Is it fair to talk about a bubble in these assets? “I hesitate to call it a duration ‘bubble’. In theory, the risk-free rate – government bond yields – should equal nominal GDP growth. And that’s what we’ve seen. So on one level it looks entirely rational. But the question then is: why is nominal GDP so low? Because inflation is low. What’s keeping inflation low? Frankly, we don’t know. And that’s what makes me nervous about trying to stimulate inflation. Because we just don’t know.”
Yet that won’t stop policymakers from trying. But while central banks haven’t exactly run out of options – they can keep trying to “flood market with liquidity”, for example – the problem is that “it’s not obvious that it’s having any effect beyond making rich people even richer”. So the government is likely to get involved. “Modern monetary theory (MMT )is getting a lot of headlines. It seems to mean different things to different people, but while there are all sorts of potential configurations, each one of those sounds incredibly inflationary to me.” However it comes about, “the next period of my career I expect to be defined by people coming to terms with inflation”.
So how has this affected the investment strategy of his pending fund launch? “It would be easy to bet on a bear market in bonds – you just go short. But what if you’re wrong for another five years? It’s not a clever way to run a portfolio.” Instead, “the fund we are launching is explicitly designed to remain robust if there is a bear market in duration assets – it doesn’t particularly benefit from it, but it doesn’t suffer either”.
The opportunity created by passive investing
Does he think it’s a tough time to be an active manager given the rise in passive investing? “I think the explosion in passive is great for active managers. A lot of these active managers who are going out of business weren’t actually active – they were pretending to be so that they could charge more fees. You look at a lot of them and they’ve got 80 stocks and their biggest position size is, like, 3% – that’s an index. Those guys are going out of business and that’s a good thing.”
“But the more investors you have who are blind to any fundamental other than market cap, the less efficient that market is going to be, and the more opportunities will exist for the increasingly small minority of genuinely active managers.”
Is the surge in passive investing one reason why “value” has struggled as a strategy? Grice takes issue with the term – all investors are looking for value, otherwise what are they doing? But if we agree to define value as “stocks with low price/earnings (p/e) ratios”, then as far as Grice is concerned “value is dead”. Why? “Any active manager who makes superior risk-adjusted returns has to know something that the rest of the market doesn’t. You have to work really hard for your alpha.” When Warren Buffett and other Benjamin Graham acolytes were making their money buying “cheap” stocks, the data was hard to come by – nobody had computers, so you needed to hunt down physical copies of company results and “it helped if you had a photographic memory too… But these days, who’s not a value investor? I can go to a free website and sort the S&P 500 by p/e. Why should there be any alpha to someone who can do that?”.
We can’t discuss investment without talking about Brexit, so I ask Grice if he sees any opportunities in British assets. “Sterling is definitely cheap, although most of your readers will already be quite long sterling. I have to say that it’s not obvious to me that the FTSE is massively cheap; government bonds are government bonds; and it’s not obvious to me that house prices are particularly cheap either. What is obvious to me is that the currency is cheap.”
Dylan Grice is appearing at the MoneyWeek Wealth Summit on 22 November in London. To book your ticket, go to moneyweekwealthsummit.co.uk