Europe could be headed for Japan-style stagnation, says Crispin Odey
Crispin Odey, founder of Odey Asset Management, fears for Europe’s economic future but believes if volatility can be tamed, he can give investors solid returns this year. He sees value in US stocks.
Talking with Crispin Odey is like taking a whirlwind course in the politics, economics and history of hedge funds, combined with strong opinions about the state of the world today.
Odey set up one of the first hedge funds in Europe in 1991 with around $150 million under management. Typical of Odey, his original intention was to operate a unit trust. However, the only people who came forward as investors wanted him to run a hedge fund. One of those first investors was financial legend George Soros.
Twenty years later and now with $6.5 billion plus in assets under management (AUM), Odey clearly still relishes “original thinking” and the freedom running a hedge fund gives him both intellectually and personally. He also clearly enjoys being in the spotlight, displaying a passion and compassion for the hedge fund industry and a flair for making not just the grand political gesture but also for stirring up passions for or against the industry.
In the first years of running Odey, he quite quickly learned the difficulties of hedge fund management. In 1993 he had a “blow-out year”, reaching $1 billion AUM.
“Then in 1994 we had a terrible time, all due to me. I basically ended up owning 35% of the long-only UK bond market and it fell like a stone. I found out how illiquid bond markets can be. The fund went from being around $1 billion to about $50 million, of which 44% was drawdown. So it was a horrible year.”
That and the turbulence of 2008 in particular taught him the importance of two things: perseverance and earning the trust of investors. Although he did not attract any new assets over the next couple of years, he turned the $50 million into about $250 million, a 400% return.
“I actually got used to the idea that I never ever would see a new customer again. It was a bit like sailing without stopping in port. It taught me a tremendous amount about being careful,” Odey reflects.
“Everyone saw me having lost 44% and then making 400% in the next five years. ‘Well he’s just very high risk, high return and he’s a bull market operator. Watch out. Next bear market he’ll have a difficult time’,” he recalls.
“I think the most important lesson which a lot of hedge fund managers learnt in 2008 was ‘know your clients’. Have a relationship with them because it’s all about trust,” he says.
“The truth is at the moment there is really no trust, very little integrity around. When I started 20 years ago, I would have said it’s performance that would dominate everything… I would now say it’s your client base that is the most crucial thing. You can’t take the kind of risks you need to take if you haven’t got the client base that will allow you to take those risks.”
Beating the odds
For Odey, it is also still about beating the odds. “I love the fact that we’re still around after a 13-year bear market. We’ve learnt a lot of things about how to run equities in a bull and bear phase. We still make lots of mistakes. We made lots of mistakes last year especially. But we’re pretty good at learning.”
Odey’s main fund was down around 20% in 2011. Coming out of 2008 and into 2009, “things became so dashed cheap that I was really buying shares as if they were options”. There was a tremendous amount of uncertainty in markets and about the companies themselves, particularly over their ability to refinance. “We had the research capability to work out if they were good enough and we bought them.”
“I said to my clients at that point, ‘hey look, we’re in a different world, in a world where the credit system is smashed but there are ways in which they could renovate it. Getting it going again has got to be a solutions game’.”
As a result Odey decided to take a risk on volatility because he believed the underlying returns over the next 10 years would prove to be 9% or 10% and much greater once credit returned to the market.
Last year he admits he took too much risk. “Instead of being net long 30% to 40% for 15 years, I started having a book anywhere from 90% to 130% net long so we were very leveraged with a view that I couldn’t believe the authorities would allow the wrong policy to exist for very long. And that was a real mistake because policy started going wrong in April of 2011 – probably in the US a bit and then in Europe. Certainly funding costs started rising sharply. We kind of missed a trick on the banks.”
Another hard-learned lesson was that politics is driving markets. “We didn’t really see how bad it was getting in Europe and still is. That meant that all the crises now happen in August because we live in these political markets. August comes along, politicians go on holiday and they haven’t made the decisions they should have before they went. The markets get annoyed that none of these decisions have been made. Last year was no exception,” he remarks.
Odey admits he was too leveraged and that his risk controls were not very good. “After having a difficult time last year, I’ve switched so we have a risk gang and the dealers are not involved in that. “
This year, Odey says markets remain tricky. He managed to make 19% in the first quarter and hopes to end the year in a strong positive position. “My net exposure is back to the 50%-90% level, which is an easier place to run a hedge fund. Also at the same time, there’s many more opportunities for making money on the short side as there were on the long side. So we’re back in a hedge fund world, which is lovely.”
Looking to the future
As the man who saw the subprime crisis coming, his views on the outlook for 2012 are interesting. He believes the US has, for the most part, “got most things right”. However, many Americans are “scared” that President Obama is bringing European welfare to the US and introducing a sense of entitlement never before seen. This, Odey believes, is not good, saying that the system has not worked well in Europe.
Dealing quickly and decisively with the banking crisis in 2008 boosted US recovery prospects. “What you’ve seen in the last two years is the banks coming back… They’ve got margins, which makes them very profitable, which makes them interested in lending.”
At the same time the US has seen house prices fall by 50%. This means that most Americans spend only 15% of their income on mortgages or rent, compared with double that amount in the UK. This has meant a bit more money goes back into the market to help stimulate sales.
Another plus for the US is the development of fracking, which has helped increase domestic energy supply and keep down prices, another boost to the economy. On average Americans pay around $15 a barrel less for oil than elsewhere.
“For me America is turning around. Credit is being extended. There’s every reason for individuals to buy houses, not to rent them there.” He sees a risk in the possible end to tax cuts in the autumn, which could be a 4% hit to the economy but believes this is unlikely to happen with the programme extended.
In Europe, Odey sees a very different story. “I’m afraid Europe looks much more like Japan, which is very sad because it didn’t have to be. The fact is that European banks and indeed UK banks, most of them, are finding themselves having to borrow at around an average rate of 2.5%.”
This is not low enough to stimulate lending. Banks are still too unprofitable. “They don’t make any money so they’re shrinking their balance sheets. We don’t have an easy money policy here. That’s the problem. You need an enormous amount of government spending for interest rates in real terms to go negative.”
Looking specifically at the eurozone, Odey is convinced Greece will have to exit. But he cautions that politics may trump logic. “The political will to remain part of Europe is very, very great. I think one should never underestimate that. I think the problem is they will probably sacrifice capitalism to try to preserve it,” adding, “It’s not a good future that I see generally in Europe on a macro basis.”
He says the hedge fund has recently extended its net exposure with around 50% now outside Europe. For Odey the only place he really wants to invest in is America. However, he concedes Asia is growing fast but that there is “very little correlation between growth and performance of stock markets”.
He believes while there is fast growth, there is misdirected investment. “One saw that with Japan in the 1980s and 1990s and we’re seeing it in China now. Essentially, you’re just investing to destroy returns in any industry you’re investing in.”
He comes back to America. “The only financials, the only banks I want to hold are in America. Having watched Japan have to sit on the sidelines for the last 20 years fills me with dread that Europe could be sitting there in five or 10 years’ time having learnt nothing. Meanwhile, America could have actually seen a growth rate of 5% or 6%. For the first time ever I really do see Europe and America having very different trajectories economically.”
Politics at fault
Politics for Odey are at the heart of what is going wrong in Europe and in the UK. He bemoans the fact the UK’s Financial Services Authority has buckled under political pressure and moved away from a principles-based approach to regulation.
“We have just seen that turned into a process-based system over the last 10 years which has little to do with the first principles on which it was built. We also have the politics now of Europe trying to destroy quite a lot of what’s good in London,” he says.
Compliance costs, notes Odey, have risen exponentially and are having a negative impact on the industry. “Principles are a very good thing and they have been lost across the board. At some point, processes are just too expensive. Everyone has found compliance has gone through the roof in terms of cost without any improvement to anybody. In the end you can’t afford this,” he states.
He believes as the political climate on the continent changes, particularly pointing to the recent French presidential election, the Anglo-Saxon style of capitalism will come under threat. “The truth about France with [president François] Hollande taking over is that his view is civilisation is all about taming the jungle. The jungle is all about capitalism and there is no capitalism worse than Anglo-Saxon. [German Chancellor Angela] Merkel is not far behind in believing the same thing,” states Odey.
The political environment in Europe is profoundly anti-market, according to Odey. “I am frightened,” he bluntly states. “Most of one’s money will be lost in taxes, not in performance. That’s why I think you have to have a strategy for getting through the next few years. The person who has the most sensible strategy will come out on the right side of it.”
For Odey, it is about freedom – particularly the freedom to make money for his clients. “I’ve spent the last 20 years making sure that I’m a free animal.” He believes hedge fund managers need “every bit of freedom in order to try to guarantee the best returns you can make. I’d rather sacrifice clients’ money not coming in than actually have to change the way in which I run the funds.”
The style of the funds will to some extent need to be modified to take into account changes in the equity markets. He says a buy and hold strategy is not going to make money any more. “The fact that equities are so disliked means that they can easily go up and down by 20% in a year.” Because of this he says he has to expect that new investors into the fund will always buy at the top. “It just becomes boring if you’re meeting investors and having to apologise for when they bought. I’m going to have to take care of some of that volatility. That’s what I’ve done this year and I’m quite pleased,” he says.
“One has definitely to reduce that volatility. If you can do that instead of making a 9% return, I might be making 15% and that feels good,” he concludes.
Looking to his own future, Odey wants to see his company growing, but emphasises clients need to be at the centre of any developments. Again he emphasises that, with politicians making decisions that are often counter to the best interests of the markets, it is a difficult environment in which to make money. “We’re 13 years into a bear market and we have $6.5 billion dollars. We have a running yield on our funds of 9%. I would be much more scared if $6 billion was all in bonds and they were giving me a running yield of 1.6%. It’s becoming a bit easier. You can just start to see where you’re going to win and lose.”
Odey’s staying power in hedge funds is based on its intellectual stimulus. Unlike many hedge funds, Odey Asset Management has not come up with a formula that it continued to use it over the years. “A lot of other friends who were long-only basically invented formulas, good formulas, sensible ways of running money. But that was the last cogent thought they had. After that, they just collected the money,” he says.
Odey has been changing its style and the way it makes money over its entire 20 years. “That’s kept me interested,” he states. “I remember very early on someone saying to me, ‘Crispin, the only thing in life is to make sure you do something that you really enjoy doing because if you do enjoy it you will beat the people, no matter how much cleaver they are, that are doing it for the reward’. Most people start with no experience and lots of enthusiasm and then end with lots of experience.”
How Odey will end is an open question. “Honestly after 20 years I’m not getting any younger.” He would like to see the company continuing after he leaves. For him the crucial element is creating a culture that is enjoyable to work in, where there is stimulus and analysis.
Odey has made a real effort to persuade talented graduates to join the hedge fund industry, according to Orlando Montagu, a partner in the company and a close friend of Odey. “He challenges bad research, whether on the sell-side or buy-side, forcing people to push further in their analysis,” he says, adding, “Crispin is building a business for the long term, not the short term.”
The question of who comes after Odey is an interesting one. He has tried to build a community with different skillsets. “We’re not too big. My feeling is I can’t say whether there’s going to be a succession. That’s not in my hands. All I can do is hopefully open the door to the next generation.”