“The scale of the COVID selloff can only be compared to the Great Depression and, to some extent, 2008.“
Boaz Weinstein is the Founder & Chief Investment Officer of Saba Capital Management, a $3.2 billion credit hedge fund based in New York City. Saba was founded in 2009 as a liftout of the Deutsche Bank proprietary credit trading group he started in 1998. Boaz leads a team of 33 professionals, with the senior members having worked together for 15 years.
As a credit investor whose formative years were spent in volatile periods, Boaz was far more interested in finding ways to capture moments where you can own volatility. Prior to COVID, credit markets were ultra stable, even in equity markets. The team at Saba examined market volatility and found opportunities when credit spreads were overvalued, leading to gains in early and mid-2020.
Prior to 2020, the next selloff was forecast to be worse because market conditions had changed. “After 2008, banks took on a less significant role in providing liquidity and taking positions.” Who ended up filling the gaps? Retail investors. This shift had the potential to cause the significant problems we’re seeing play out today.
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SPEAKER
Boaz Weinstein
Founder & Chief Investment Officer
Saba Capital Management
MODERATOR
Anthony Scaramucci
Founder & Managing Partner
SkyBridge
EPISODE TRANSCRIPT
John Darsie: (00:08)
Hello, everyone, welcome back to SALT Talks. My name is John Darsie. I'm the managing director of SALT, which is a global thought leadership forum at the intersection of finance, technology, and public policy. SALT Talks are a digital interview series that we launched during this work from home period, with interviews featuring leading investors, creators and thinkers. What we're really trying to do during the SALT Talks interview series is replicate the experience that we provided our SALT conference series, which takes place annually in Las Vegas as well as internationally and most recently we did in Abu Dhabi. What we're really trying to do is provide a platform for what we think are big ideas that are shaping the future as well as very interesting investment ideas, and also provide a platform for subject matter experts.
John Darsie: (00:52)
Today, we're very excited to welcome Boaz Weinstein to SALT Talks. Boaz is the founder and chief investment officer of Saba Capital Management. Boaz founded Saba in 2009 as a lift out of Saba principles. Mr. Weinstein leads a team of 30 professionals with the senior investment team having worked together for 17 years. Prior to founding Saba, Boaz was the co-head of Global Credit Trading at Deutsche Bank. In that role, he was responsible for overseeing a group of approximately 650 professionals, and he was a member of the Global Markets Executive Committee at Deutsche Bank. Throughout his career at Deutsche Bank, Boaz had a dual responsibility for proprietary trading and market making. In proprietary trading, he founded Saba principle strategies to specialize in credit and capital structure investing. As a market maker he focused on credit default swaps, investment grade bonds and high yield bonds.
John Darsie: (01:46)
Boaz worked at Deutsche Bank for 11 years the last eight, in which he operated as a managing director, a title he received at the age of 27. Boaz graduated from the University of Michigan, he's a Michigan man with a bachelor in philosophy. He grew up in New York City, and attended Stuyvesant High School where he's currently on the board of directors. Boaz is also on the Leadership Council for Robin Hood, which is a well known New York charity that is the largest New York charity fighting poverty within the city. A reminder if you have any questions for Boaz during today's SALT Talk, you can enter them in the Q&A box at the bottom of your video screen on Zoom. And conducting today's interview is going to be Troy Gayeski, who's a partner, Senior Portfolio Manager and the co-chief investment officer at SkyBridge Capital, which is a global alternative investment firm. And with that, I'll turn it over to Troy for the interview.
Troy Gayeski: (02:36)
Yeah, thanks, John. And thanks, everybody for dialing into SALT Talks. Boaz, it's an honor to have you on here today. And before we get into the meat and potatoes of your investment opportunities, and all the various complex securities you're focused on, let's take it back a little bit, growing up in New York, going to Michigan. How did you transition to Wall Street? And then we can spend specific time in your career at Deutsche Bank, which is so formative for your success.
Boaz Weinstein: (03:03)
Thank you Troy. It's really a pleasure to speak with you and everyone on today. So my start on Wall Street really required like many people's a good deal of luck. I was interviewing like a lot of people might, sending in the letters and you get the recruiting officer to do the good service of meeting with you for 15 minutes. But as I was leaving, and this was at Goldman Sachs, as I was leaving the interview, I went to use the restroom and lo and behold, in the sinks washing his hands was someone I'd met once before, who I hadn't even realized was the partner in charge of the high yield business for Goldman. So were it not for that moment, my start on Wall Street would have been quite a bit later. I had had a job after school with a very formidable mother, daughter duo at Merrill Lynch, who are stockbrokers. But my real start on a trading floor came at Goldman and so I did that each summer as an undergrad.
Troy Gayeski: (04:00)
Got you. Boaz, thanks for that brief color, but from there going to Deutsche Bank. I mean remember you back in the crisis stage, you were a legend, given the volume that you put on, and various complex trades. So you want to talk about how that experience helped segue you to today and what particular lessons you learned while at DB?
Boaz Weinstein: (04:23)
Sure. So all through my early career on Wall Street, I had been interested more in technicals and quantitative strategies than pure fundamentals. In the credit market when I started, Troy was really this is pre credit derivatives, it was really analysis of what's the likelihood a company will get downgraded or its cash flows will not be sufficient to pay back the debt. And it required a tremendous amount of knowledge about distressed and accounting and less about the math. Whereas in other parts of fixed income, there was a lot of math, different spline models for government bond pricing and options models. So I needed also the good luck of the credit market to mature enough to have a credit derivative market in time for me and to be at a good place to do that.
Boaz Weinstein: (05:18)
So all that coalesced around 1998, where the credit market was still in the real tremendous infancy of the beginning of the derivative space, even though for foreign exchange, for equities, for lots of other asset classes, derivatives had been around since the '70s or prior. So when I was starting out at Deutsche in 1998, there was no book on how to do things, most of the credit investors, most of the market makers and traders knew the old way. And when credit default swaps came about all of a sudden, going short was much easier than in the past, you didn't have to worry about a bond borrow. You could set up curve trades that you couldn't really do efficiently. You could look at all sorts of strategies that some of which were borrowed from other asset classes, and some of which were fairly new, like how do you really think about comparing a bond to equity options. And out of the money put on an equity is not all that different, when you think about it from a bond.
Boaz Weinstein: (06:20)
In that it will only pay off when a dramatic giant sell off has occurred and that put goes in the money. Similarly, in credit, even if a company goes from triple B to single B, if it doesn't default, you get your par back. So starting at the right time, starting at the right place, and then the third ingredient was also the volatility. So my vintage coming out of college and investing, had I started five years earlier, and markets had been really tranquil, or in some period, if I'd experienced a market with very little volatility, I'm sure that would have had its influence. Instead, the year that I really had risk taking capabilities in 1998 and onward, we have the Russian default, long term capital management blew up.
Boaz Weinstein: (07:08)
And very soon thereafter, there was plenty more, not just 911, trading through that day of 911 but of course the defaults later that year of Enron, and then the following year of Worldcom, and all of everything that came after. So I was someone as a credit investor, whose formative years were spent in volatile periods. And that really made me much more interested in trying to find ways to capture moments where you can own volatility, or you could have asymmetric position that will do well in a volatile environment. And that led to a lot of the things that we then developed.
Troy Gayeski: (07:45)
Got you. So obviously a combination of brilliant mind with luck. I'm glad you referenced that, because especially in the tough times, you're going into now people tend to forget just how lucky we are to be in this industry and to be in the seat that you are today. So how did those formative years compare and prepare you for today? And what were the differences or similarities between the March, late February, March, early April debacle, and some of the past historical market disasters you've managed through?
Boaz Weinstein: (08:17)
Right, so the scale of the sell off of COVID in February, March was so severe that people only are really comparing it to the Great Depression and to some extent 2008. I've thought a lot about this question, not only since COVID, markets have calm but in that moment, about what kind of market are we in? So maybe one of the first things to say is that prior to the COVID sell off, or the COVID crash, whatever you want to call it, credit markets had been ultra stable, even in the face of moments of equity market volatility. So if you go back to 2018, when tech stocks had a giant run up in January, a giant sell off in February, and the VIX blew out. And then later that year with China trade war stuff in Q4 18, there was again a giant blowout in equity markets, vol spiked, VIX went into the 40s and plus and credit markets really held.
Boaz Weinstein: (09:17)
I think some of that was based on the right reasons. That if you have a booming economy, a low default rate, low yields in the world, everyone needs to find yield somewhere that the credit market can be resilient, especially if it has been resilient. But the credit market to me is I look at it also as a space where when spreads are low. That spread we could call it [inaudible 00:09:42] yield, bond, interest. We can also look at it like premium, you're getting premium, and we can compare that to other other environments and to say that when the spreads are quite low that you're still never going to earn more than that spread. If you're an investor, lucky investor in Apple or pick a super thriving company, as a bond holder, you're never getting better than par and your coupons. So for you, volatility, uncertainty is just it's a four letter word because you're never benefiting from it, you never have the upside, you only have the asymmetry against you.
Boaz Weinstein: (10:16)
So I've tended over the years especially to look at volatility as a sign for when credit spreads are overvalued. So when credit spreads are too low, but volatility is high, and we'll get to that in a little bit. You can think about the credit investment, like you've sold an option at a spread that's just too low. So in going through COVID, what was in many ways it bore resemblance to past dramatic sell offs. And that credit did fall on a very heavy delta. So we did have credit markets, especially on the bond side, much less than derivatives falling precipitously, companies that pre COVID were extremely well regarded. Let's take an Occidental Petroleum or go into the heart of the storm, a Royal Caribbean, for example, who had both of them had very low credit spreads and they saw those credit spreads go, not just 100% wide or 500% wider, but go 1000 or 2,000% wider.
Boaz Weinstein: (11:18)
So in that world, credit fell for many companies very heavily compared to equity, sometimes even almost one for one. So quite different than '18 and quite different than in some other sell off. So in that sense, in more resembles '08 and I remember, prior to 2020, a lot of people talking about how in the next sell off, things would be worse, because of the market dynamics, how the market had changed. The main way the market had changed in my view, in terms of the underlying participants, is that after '08, the banks took on a much less significant role both in providing liquidity and in taking positions. So people have speculated, well who's filled in the gap. And if retail investors have filled in that gap and retail investors own all of these ETFs and mutual funds, and BDCs and closed-end funds.
Boaz Weinstein: (12:15)
If we are to have a big sell off, and now retail can get out on one day's notice from some of these products, and some of these products have leverage that causes them to have to sell in a downturn. But mutual funds and ETFs have to sell that day that the rise of retail and the drop off in banks, as a shock absorber would create a problem. So people talked about it for years. And we saw in 2020 I think the most meaningful thing was to see that in action.
Troy Gayeski: (12:42)
Got you. Yeah, clearly, not having the dealer desk step in to provide liquidity was a clear detriment to price action. But on the other side of that, obviously, the lack of participation from prop desk creates good opportunities for folks like yourself to trade, correct?
Boaz Weinstein: (12:59)
That's right. We saw things that people thought you ought not to see. So just a simple example, various ETFs not even little ones. I may name some giant ones like the BND, which is meant to replicate the bond index, or the AGG, the AGG were trading on the worst days of March at giant discounts to their net asset value even as much as four or 5%, which is huge when you think about [crosstalk 00:13:25].
Troy Gayeski: (13:25)
[crosstalk 00:13:25]. Yeah.
Boaz Weinstein: (13:26)
And then there were ETFs that were trading at 15, 20% discounts. So we saw opportunities for funds like ourself, where dislocations were enormous, discounts on closed-end funds, differences between skyrocketing equity vol and credit spreads. So it has been for us a historically good year. I think maybe the most interesting part is even as I talk with you today, and the markets in many ways have calmed although we have an enormous amount of uncertainty to follow for the reasons we all know and some that maybe we'll bring up. But even though markets have calmed the dislocations really remain. Normally you see dislocation in the heat of the moment, and then the market stabilizes and things go away [inaudible 00:14:11]. But even today, you have some things that I'm not used to seeing before. I'm really unaccustomed to certain relationships being so stretched in times when markets are near their highs.
Troy Gayeski: (14:24)
But again, part of that is back to lack of prop desk competition, in that you don't have these big balance sheets to step in and normalize the relationships, correct?
Boaz Weinstein: (14:33)
Absolutely.
Troy Gayeski: (14:35)
There are guys like you still on the street. Right? You can go after it.
Boaz Weinstein: (14:40)
Yeah, no, that's absolutely right. We have had that phenomenon for a decent amount of time. The banks did pull back more than a couple years ago. So it's more like that's absolutely right. It's just how dramatic it is. And we did see in February, March really the banks unwilling in many cases to provide liquidity and as a result things got especially stretched. So that's been great for a number of funds like ourselves.
Troy Gayeski: (15:07)
So Boaz, that's a great summary into your insight into markets as they were then as they are today. On the fundamental side, you know you don't focus on this with all your research, but could you walk us through the path of high yield defaults that you see? I mean, we remember in March, April, some of the forecasts were close to a trillion dollars between levered loans and high yield. Obviously, things aren't going to become that bad. But just walk us through what you see fundamentally in terms of default rates, recovery rates and high yield and levered loans.
Boaz Weinstein: (15:38)
Okay. So first, I'm glad you said recovery rates, because it's one thing to talk about how many companies are defaulting. But what's been noticeable in this environment is the severe drop off in recoveries. So there was just an auction last week for noble energy and the recovery on the bonds was literally one cent on the dollar. A few, maybe six, seven weeks earlier, JC Penney defaulted, the recovery on those bonds was not one cent on the dollar, it was one eighth of one cent. So we're getting rid defaults, where there almost counting one and a half or two for one. So the severity, so if you think about your expected loss being the frequency something occurs, times the severity, the recovery rate being very low is really important to mention since that's actually critical to how much a long investor will lose.
Boaz Weinstein: (16:32)
The other thing is, from a fundamental side, is that the default rate didn't start ballooning right after COVID began. We already had last year some warning signs, whether it was Sears, a retailer that finally was defaulting, but people wondered, is JC Penney not going to go down that path, or we had Dean Foods, that was kind of a surprise, if you look back a couple years earlier. So Parker Drillings, so energy space defaults. So we had a lot of defaults in 2019. In Europe, we had Thomas Cook, 200 and something year old company. So in normal environments where credit spreads are ultra low, as they were Troy, just seven months ago, you normally have in an ultra low credit spread environment, very little losses that you've recently felt. But if somebody gets punched in the face seven times, default after default, in 2019 what's kind of been interesting about the market is that the rest of the pool has not widened to compensate.
Boaz Weinstein: (17:34)
What's instead happened is that people get up on Bloomberg and CNBC and talk about how there is no alternative, yields are at zero and in so getting 3% spread in high yield isn't so bad. But what I think is really interesting from the fundamental credit side, is if you look at defaults and recovery rates, not only were they high in 19, not only they've been defaults that is, not only the [inaudible 00:17:59] super high in 2020, we've had 10 defaults this year in the index that the 100 names that best capture the high yield market on the derivative side, the 100 biggest companies, 10 of them defaulted this year, six last year. So not only have we had that happen, but if you look at the pool, and you look at it by quartile or however you like, by decile, what you find is actually out of that 3% that the pundits say ain't so bad, disproportionate high portion of it is coming from distressed fallen angels.
Boaz Weinstein: (18:32)
I don't think when a credit investor says I need yields, give me something that's three or four or 5% yield, I don't think they're counting on a bond trading at two cents on the dollar with a 500% yield to be part of that return. They all understand that the yield is stretched because of those wide names. So I think one of the hallmarks of the mispricing in 2020 in February, and it's coming back to again today is people ignoring the heavy amount of fallen angels that sit in the investment grade pool, and then are kicked out when they go to high yield like an Occidental Petroleum or Royal Caribbean. Or the high yield pool that despite 10 defaults is still sitting there with another 10 companies that are very much in trouble such as transition. The ticker for that is RIG to give you an example of even after those defaults, there's a lot more coming.
Boaz Weinstein: (19:26)
So I think that COVID fundamentally, it's not going to be a smooth recovery if we even get as big recovery as people expect. And what will be left behind are stressed companies that even in this bull market are exhibiting stress. Even American Airlines and then I'll pause, American Airlines which the president has been vociferously defending as, "We are going to protect American Airlines. They're going to get financing that they need." The equity market kind of believes it. If you look at the market cap of American Airlines, there's still a lot of equity value. The credit market is very skeptical of American Airlines, as evidenced by the enormous credit spread, the enormous probability of default that's being baked in. So high yield to me is really still a very interesting, vulnerable space where optically the spread is exaggerated because of fallen angels.
Troy Gayeski: (20:18)
Got you. So given that focus, could you walk our viewers through some of the exciting trade opportunities that you had on earlier this year? How they were monetized, and then some of the better opportunities today?
Boaz Weinstein: (20:32)
Sure. So when we do that unpacking of, "Okay, here's the index, but what's going on beneath the index." You can find that back in February and to a large extent even today, the best in the index, the best quartile [if you will, is trading at such tight levels. Let's take the high yield market for an example where it's not that we're saying, "Oh, the credit market has [inaudible 00:20:57] totally wrong, these are not good companies." It's just, this is the wrong price. So to go back to February, then I'll go to today, there were situations where pure market technicals, which I want to stress in this discussion we're having. I see this market as even though we can talk more about fundamentals and talk about the likelihood of the default rate staying high and so forth. I see the market driven very substantially compared to other times in my career by technicals, who's doing what to whom.
Boaz Weinstein: (21:29)
Even if the credit spread ought to be at X, sometimes you'll hear a market maker at a Goldman Sachs say, "Well, because it's included in this index and because this index is being heavily sold, or heavily bought, or there's an arbitrage on this index, and they're not enough guys like you to buy protection, credit spreads on certain companies that are technically offered or bid can trade a dramatically different levels than their fundamentals." So we've been focused less on fundamentals in these last few months, because we see the market being almost dominated other than for real workout distressed situations where of course, it's going to be about what actually happens. But in the meantime, technicals are driving a lot of the market. So for example, in February, the quartile, the best quartile of the high yield market was trading at a credit spread of 46 basis points.
Boaz Weinstein: (22:22)
46 basis points we all know is a very low number. It happens to be even lower than the average investment grade. So when we looked in that quartile, we saw some Double B companies that were not on their way to triple B, they were either going to stay at double B, they had double B leveraged metrics, others credit metrics, or they were maybe on their way to single B. So as an example, how could companies like a Saber, to take online travel company? How could Sabre simultaneously in February be trading at the same credit spread as McDonald's or IBM? McDonald's and IBM, we can wonder, are they going to retain their past glory? They're never going to default in any kind of reasonable world, but a double B company shouldn't really trade at where IBM is trading. So we bought protection on companies like Sabre, which also included United Airlines, and included lots of things unaffected by COVID. But we're just too darn tight and [inaudible 00:23:20] SALT protection on companies that we thought were safe like IBM.
Boaz Weinstein: (23:23)
Now, let me just say for three seconds, IBM was trading or is trading not on fundamentals, but because they had acquired Red Hat, the banks needed to offload that risk. And again, the banks didn't think IBM was a problem credit, but they just needed to buy the protection. So we have this world that I've never seen in my career where double B, single B companies are trading at the same spread as Verizon, IBM, Disney, AT&T. So we constructed a long short portfolio of what we would call valuable tail protection paid for by what we would view as very poor tail protection, i.e the McDonald's Disney example. So that worked exceptionally well in the sell off, and not just COVID type of names like Royal Caribbean. And even today, in this melt up that we've had in the last couple of months, we again have credits that it's either or. It's either they're trading super tight, or you have these exceptions that are dominating the spread.
Boaz Weinstein: (24:21)
So one way to finalize that and then I'll talk about a live opportunity is that if you compare credit spreads one year ago to today, you find that in the zero to 40 bucket. This was a chart I saw recently from Barclays. In the zero to 40 basis point bucket, what today there are far more credits 20% in the index more is now in that bucket in that ultra low bucket and every other bucket until the widest bucket has less constituent because they've all moved to the ultra low or they're the problem names like a Royal Caribbean or an Occidental. So you have this kind of all or none society where the average is a moderate credit spread, but you're either at zero degrees or you're a 200 degrees. So when we unpack that we find a lot of interesting trade ideas.
Boaz Weinstein: (25:10)
So today, we still see opportunities to short, double B rated companies at double digit spreads and go long, very safe single A companies like AT&T, [inaudible 00:25:20] which is triple B, but is not in danger of getting downgraded anytime soon. And if it did, it's almost a bigger deal for the high yield market than for AT&T, and pairing those together. So that's one type of idea and then I have a very brief idea to talk about with American Airlines if we have time for it.
Troy Gayeski: (25:39)
Boaz, we always have time for you and American Airlines. You referenced President Trump, we have an election coming up. Let's talk about that American Airlines opportunity.
Boaz Weinstein: (25:48)
So we found it through our screens but I've also had some friends in the industry, one in particular, who was less involved in credit, asking me what I thought. Because the thing about cost structure trades, American Airlines credit against equity, it can look good in a screen, it can look good at time zero, but [crosstalk 00:26:06].
Troy Gayeski: (26:06)
Boaz, you want to step back for one second and explain what a cap structure arbitrage looks like, not everyone is familiar with it as you.
Boaz Weinstein: (26:15)
Thank you, Troy. That's a good idea. So for many people cap structure would simply mean, I go long, one part of the capital structure, which in the continuum starts with equity, and then you have preferred and then you have subordinated and senior unsecured and senior secured, firstly, and secondly. So there's different levels of security in the debt. And so you might pick one safe thing or unsafe thing and trade one against the other. One of the nice things about that strategy is it's the same company. You don't have to worry, did you get like one company, long short, one company versus another company right. It's the same company. So that's interesting. And for many people, it's secured debt might be attractive compared to unsecured debt. In American Airlines, what we think is really interesting is that what even though a cap structure trade can be tricky, because the company can change its capital structure, a company of course, can issue debt to buy back stock or issue stock to buy back debt or something in between.
Boaz Weinstein: (27:23)
The way the uncertainty should work in this environment, if you look back to '08 with what happened with AIG or Fannie Mae or other kind of bailouts is that generally, the equity might be left for not. We had that of course with Bear Stearns, and a bunch of other situations where the equity either gets heavily diluted or bought for very little by the entity that's taking it over or providing the financing to it. So what we've noticed is interesting about American Airlines and I saw Seth Klarman wrote something similar in one of his letters about AMC Entertainment, the movie theater company, is that you've seen the debt fall really precipitously. And in some cases, the stock is as high as it was, or not an American Airlines case, but you see where the stock really hasn't fallen very much from pre COVID. So American Airlines today has an enormous market cap. Now, it was certainly higher beforehand, but it's obviously producing losses each and every day.
Boaz Weinstein: (28:24)
So you have all this equity value leftover for the stockholder. And what's at odds with that is that the debt you can find pretty short dated bonds trading like they're going to default. Whether it's a three or four year bond at 40 or 50 cents on the dollar, or it's a secured loan, first lien loan, where you have some of the best collateral in that loan. Whether it's the gates at Heathrow, or whatever it may be, and those loans have fallen very hard down from par down to 60 cents on the dollar, where even if the company were to default, those loans might still not be down from here. So when a trade like that, what we're doing lately is pairing those things, is buying that the cheapest part of the debt side and hedging it with puts on the equity.
Boaz Weinstein: (29:13)
So in that case, there are a number of hedge funds, I think that are willing to go along American Airlines debt, but they want a hedge, they want to out and for us, that's downside protection through the stock. So that's an example of one trade that is a household name, everyone's heard of American that stands out to us as really unusual.
Troy Gayeski: (29:36)
Wow, that's an interesting opportunity, takes you back to the 2003 days where you had tremendous cap structure arb opportunities right before again the dominance of distress hedge funds, because people forget, but that '08, '09 period, there weren't a lot of cap structure arb opportunity. Certainly not like the one you're describing today. So that brings us to a point of the disconnect that some see between certain pockets of credit markets and equity markets. You gave that very localized example. But is this a general trend you're seeing across companies that are at risk of bankruptcy, credit investors saying one thing and equity investor saying something else.
Boaz Weinstein: (30:14)
Actually, American stands out because there aren't a lot of opportunities like that. What does stand out and this will resonate, I think with a lot of people watching is that we've seen equity volatility, the cost of buying those puts or calls. Equity volatility is actually the thing that today remains very elevated. So if you just think about the VIX, which is the fear gauge, you can't go an hour or two without someone talking about it. In the financial press, the VIX, which had touched single digits, and was ultra low a mere three, four years ago, today is at a level that would suggest rough markets ahead, or at least lots of uncertainty. So the VIX, at one point last week was back in the 30s. Today, it's at 25. So I think the high level of equity vol is that extreme odds with the low level of credit spreads. Let's go back to my earliest point, that as a credit investor, you're not getting paid for the volatility, you're never going to do better than your yield minus the default rate and the loss that those defaults cause.
Boaz Weinstein: (31:24)
So you have a very capped return when credit spreads are low, it's a low number, and you're there for presumably for safety and for yield. The higher the volatility is, and you can look at the equity market as a reasonable, efficient market. The high the equity volatility is telling you there's a lot of uncertainty, and then you scratch your head and say, well, do I agree with that? Yes, Troy, you and I together could probably cite a dozen things, at least three or four that are highly uncertain. If there's a democratic sweep, will capital gains taxes go up? Will corporate taxes go up enough to cause some high yield companies to have problems who otherwise might have not?
Troy Gayeski: (32:06)
[crosstalk 00:32:06], how about when we get the fiscal stimulus that people thought would arrive by August 15 for [inaudible 00:32:10] the latest?
Boaz Weinstein: (32:12)
That's in my top five as well. I mean, and then there's this, people are confident there's going to be a COVID vaccine but that doesn't mean certain companies that are really suffering are going to really benefit and maybe not in time. If we could have this many defaults in the first half of the year, and the market is now pricing almost very few to come. So you make that list, you include things like China, the tension with China and you look at the level of vol, and you say, "Well, look, I can see why the next few months are going to be volatile." So when I look at the across cap structure, I have never seen so many cases where credit spreads are almost back to where they were pre February. And equity vol just remains 20, 30, 40 points higher than it was pre February.
Boaz Weinstein: (33:02)
And while we can rationalize it based on the scary uncertainty to come in markets, which by the way, as an equity investor is also something to think about, but at least in equities we've seen in the last few months, you have enormous upside. And certainly that's even without picking the right stocks. So equities offer somewhat of a symmetric investment in fact asymmetric because they can go up more than 100%, as any Tesla shareholder can tell you. So the asymmetry volatility is not a bad word for stocks, it is for credit, especially when credit spreads are low. So I think the kind of standout point about markets right now is the ultra high level of all which can be explained by vol funds having blown up in March, it can be explained by the macro factors you and I just talked about. But it is impossible, in my view, to rationalize the ultra high level of vol and the ultra low level of credit spreads, save again for the fallen angels.
Troy Gayeski: (34:01)
Yeah, it's amazing to look at the on the run high yield index back to 360 over. I mean, who thought we'd see that so soon after February, March, tribute to the Fed's balance sheet and massive money supply expansion. Right?
Boaz Weinstein: (34:15)
Yeah, that's right but there's this survivor bias in credit where it's 360 over and that pool is 360 with 10 names having been removed that caused investors seven point hit. And that 360 has Transocean trading at 9000. Pull out Transocean that 360 goes to 338 or so and then you pull out another one. So that's the interesting thing is that spreads. It's amazing what's happened. I totally agree. And it's even more amazing than that, because spreads are in this winner take all, it's either trading like gold, or it's trading like it's going to default, not to exaggerate the point. So I think, with a little bit of detective work, you can [crosstalk 00:34:58].
Troy Gayeski: (34:57)
With a very low recovery too. Don't forget the recovery as well.
Boaz Weinstein: (35:01)
With a very low recovery rate. So you're going to end up in a place where actually credit, you were really betting that the deeply distressed companies, were not going to default. And I don't think that's what investors are trying to do. Because let me say it this way, out of that 360, the top half of the index, the better half is only giving you about 130. So if I said to you, Troy, "Hey, would you like this high quality, high yield portfolio? You can get 1.3%." You might say, [inaudible 00:35:29] spread, you might say I think I'd better things to do with my money, but that gets lost a little bit. And again, when people talk about it as a big blob when it's so desperate.
Troy Gayeski: (35:40)
So Boaz, last question before we turn it over to the audience, but you're legendary poker player. I couldn't let you go without pointing that out. You just talked about how expensive equity vol is and how cheap credit vol is. Would you be brave enough now to sell equity vol and buy credit vol or is that just too dangerous of a trade question?
Boaz Weinstein: (36:01)
Also I enjoy poker, I'm actually quite a bit better at some other games.
Troy Gayeski: (36:06)
Is that right? Yeah.
Boaz Weinstein: (36:10)
I think there are no ways to really trade credit single name, as from a through options. It's interesting, there are no equity. Like in equities there puts in calls, you don't have that in IBM credit, you have it in IBM equity. So I look at credit like this asymmetric thing that if you're long credit, you're shortfall and if you're short, your long vol. And it's a question of price and that price, what we have found lately is that for companies, I'll give one example, Devon Energy, DVN, it went 500 wider into March and it went 450 tighter back. It went enormous 500 wider 500 basis points for five years is 25 points, 500 times five. You PV, that to today, it's about a 22-point move we had back in Q1 and a kind of a 20 point recovery. So the credit spread is very low. We recently saw that it could be very high. We saw that in 2016 as well. The equity vol is very high. So what we've been doing is buying CDS on companies like Devin and funding it by selling out of the money equity puts.
Boaz Weinstein: (37:19)
I've never done that in my career, because it was never interesting to do it. The great part about the trade is that for if you wanted to get rid of your negative carry for every 100 million, for example, that you would short of the credit, you only need to go long about four or 5 million through the equity. So it's an enormous ratio, and it will behave very well in a sell off. What we've been seeing lately with the declining price of oil, our energy stocks come under pressure again, and whether it's Occidental Petroleum or Devin. So we think especially in the energy space, some of his very low credit spread, high equity vol is an opportunity to set up a pair trade as you were alluding to Troy.
Troy Gayeski: (37:58)
Yeah. So that's interesting. First time in your career, it's been this inefficient. That's remarkable. So well Boaz, I'm going to turn it back over to my partner, John Darsie who's going to read off some of the questions from the audience. And if we don't get enough questions from the audience, you and I can keep talking for quite a bit longer, I'm sure.
Boaz Weinstein: (38:15)
Sure.
John Darsie: (38:16)
You guys could go on for a couple more hours, no problem. And blackjack is Boaz's game, come on Troy.
Troy Gayeski: (38:23)
My memories it's not what it used to be.
John Darsie: (38:29)
So I want to talk about closed-end funds for a moment, Boaz. They've received a lot of attention for activism and discounts in recent years, and you've been sort of in the middle of that mix pushing for some restructuring in the space. Are there still arbitrage opportunities in the closed-end fund space? Are those starting to go away?
Boaz Weinstein: (38:47)
Well, so the closed infinite space has plenty of arbitrage opportunities today. When I got into it, about seven years ago, I thought that all fixed income closed-end funds, or at least most of them would trade very similarly. In the end, a pool of 500 bonds and loans managed by BlackRock or PIMCO or Platinum, they're not going to behave that differently, so why should the funds? Why should they trade it at a different levels of discount? But starting in 2013, closed-end funds, after a few years where they were trading at their net asset value or at a premium, you could buy closed-end funds at a deep discount. And I like the idea of buying $1 of assets that I already wanted, like high yield in a world of low yield to be able to buy something, that it's not my valuation, that $1 is something I'm buying for 90 cents or 85 cents.
Boaz Weinstein: (39:39)
But that actually, the same valuation tool that's used for ETFs, used for mutual funds is same thing for closed-end funds, the same pricing source and so it was unambiguous that closed-end funds were trading at this true discount. So what was interesting to me was that some of them would trade at plus one and some of them would trade at minus 15. Jeff Gundlach would trade at minus 12, then he talked about it, or Barron's, write about it and go to plus one. So I liked that this wasn't a discount that was just structural. There are a lot of things where people say, "Hey, this is cheap." And the response back is, that's been cheap for the last 15 years, or that's been cheap for the last five years. Closed-end funds were something that were attractive that we felt we could do something about.
Boaz Weinstein: (40:24)
So in the last seven years, we've built a business out of trading them, analyzing them, and also finding situations where the rights of shareholders are such that if we accumulate a large enough stake, that we can have a positive outcome for all investors, where either they turn the closed-end fund into an open ended fund, as BlackRock did for us and other investors this year, we have to take them to court. But two of the funds that we sued them over, they ended up in our view, doing a great thing for shareholders by merging them these municipal funds with their open-ended funds, and all shareholders saw an immediate gain in a permanent gain as the discount went away.
Boaz Weinstein: (41:09)
So as I talk to you today, John, we're buying some closed-end funds at 16, or 17%, discounts to their fair value. More often, it's more like 13 or 14. And to me, that's an enormous discount. And again, a world of very low yields, where the discount gives you some extra yield. And hopefully Saba's activities will cause that discount, to converge to net asset value. Something we've done this year, particularly successfully and getting managers to in our view, not think about their [AUM 00:41:42] and their fees, but think about their suffering shareholders.
John Darsie: (41:46)
Switching gears a little bit, we certainly don't have a shortage of audience questions. And thank you, everybody who's who's tuned in for your engagement. Private equity firms have been shown to be more likely to overload their businesses with debt, with weak covenants. And we've seen several examples of that recently, with things like Chuck E. Cheese or [inaudible 00:42:04]. Do view sponsor bank capital structures is more likely to default? And are the weaker credit profiles of sponsor back companies priced into CDS markets effectively?
Boaz Weinstein: (42:15)
It's certainly the case that a number of the defaults that have occurred in the last couple years have been LBO related. But also some of them had the wherewithal because of their sophistication in capital markets in terming, out the debt, I think, back to Texas utilities, being a company, the KKR LBO where people thought Texas utilities ought to default, but it was able to continue on for years trying to do various different kinds of financial engineering, bond exchanges. So I don't have a view of any kind of negative view about private equity. And it's not even my expertise but it is true that when you add a lot of leverage to companies, and then you go through downturn, some of them are going to default. So for the question, if it means if highly levered companies is... I don't know if if you if it's too much.
Boaz Weinstein: (43:11)
I think that that private equity has certainly added great value in many examples, as well. I look at some of the defaults this year, whether it's Hertz, which was trading great, until a few months before COVID, or Chesapeake Energy, or JC Penney. These are not the result of private equity.
John Darsie: (43:31)
We'll leave you with one last question from the audience. How do you explain the difference in your recent success strategy buying CDS, versus some of the experiences that you had in 2008, prior leaving Deutsche Bank?
Boaz Weinstein: (43:45)
So I think that our portfolio is certainly different, it's been 12 years, and it also might have learned a thing or two. But every sell off is different. I think 2008 was its own thing, in that people were worried the financial system was was ending. I actually think back now to that to that September period, I was actually at the New York Fed representing Deutsche Bank, as being the co-head of the credit business. I was there that weekend when Lehman was unraveling, and really, relative value trades, which has been the hallmark of our business, were unraveling just like everything else, even if it was reasonable to own secured debt and be sure to unsecured everything was suffering, because people were worried that leave aside Lehman and Bear that Merrill Lynch, Goldman Sachs and Morgan Stanley, were not going to be there.
Boaz Weinstein: (44:40)
So a lot of relationships got out of whack. I think the Fed and other entities and government have done a great job to reduce that risk. So now when We trade in credit default swaps for example, there is a clearinghouse that trades all of the index product and a lot of single names available to mitigate counterparty risk. And so I'd say this crisis harkening back to Troy's question about how this is different, is also different in that the banks were not on people's radar for being the problem. People, think about the last six months, no one was talking about what's in the books at Goldman Sachs or Morgan Stanley. I think that that's one important difference. I also think our portfolio is well suited today, and for the last few years for volatile moments, even more so than in the past.
John Darsie: (45:33)
Well, Boaz, thanks so much for such a great wide ranging conversation. Troy, do you have any final words or thoughts for Boaz, before we let him go?
Troy Gayeski: (45:40)
No, Boaz, just a simple question for investors, if you think of the opportunity, maybe to be long protection, as of February 1, the benefit of hindsight, which is probably a 10, versus the relative value opportunities you're seeing today, would you rate them more of a five, meaning great return prospects, but not explosive? How would you think about that? Tough question to answer but...
Boaz Weinstein: (46:04)
Yeah, it's so tough, because if we talked in January, and I said it's incredible. You and any other reasonable person would say, but maybe it won't be three years before anyone cares. If the markets are just going to be a sea of tranquility, what does it matter that this was mispriced to that? So now the credit protection in many cases is back to pre COVID levels and we can explain it by the Fed and lots of other reasons. But the cat's kind of out of the bag that such giant sell offs, like we saw can occur and even though the Fed has dug deep into their toolkit to come up with a broad set of things that people didn't expect. I think that the high level of default that we're seeing in high yields, even if it's abating to some extent, we are in a much more trouble time today that I think everyone would agree than we were six, nine months ago.
Boaz Weinstein: (47:00)
So I think that that relative value trade of short, high yield and long safe investment grade, I think it's as good as it was before, even if the levels a little worse, the circumstances are a lot better. And the relative value remains, I'd say considerably better than it was a year ago. That doesn't mean our trades are going to work out eight out of 10. But just the entry points into via closed-end funds that John asked me about, buying stuff at 14 is a whole lot better than buying stuff at nine or 10 as we had in January. So RV is more attractive for sure and the kind of tail protection, you can argue it both ways that it's a little bit more expensive, but I would argue adjusted for the risk. It's probably as good or better.
Troy Gayeski: (47:44)
Great. Well, thank you so much. That was very concise.