Steven Drobny’s book “The New House of Money” starts with a 25-page-long interview with Kyle Bass, a 48-year-old Texan hedge fund manager. The lines below are the essence of that interview, which will give you an insight into the life and work of this outliner with bold ideas.
The interview begins with a quick intro into what preceded launching and running of his hedge fund in Dallas and him dealing with subprime mortgages – Kyle talks about his beginnings in Bear Stearns’ office in Dallas as well as where and when he started his journey of working with event-driven funds on investment strategy.
After years of investing in restructurings of the home health companies, merger arbitrage, spin-offs, etc., he signed a five-year deal to start Legg Mason’s institutional business in Texas in 2001, where he tried his luck in covering long-only mutual funds. Having clients like Dan Loeb, Alan Fournier, Jody Lanasa and Rehan Jaffer was fruitful for him. Four years later, in December 2005, when he turned 35, he launched Hayman Capital Management with $5 million of his capital and $28 million which came from people who added value over the years by listening to his financial advice. And the timing was right – just before the U.S. housing bubble collapsed and prior to housing prices peaking in early 2006. Young hedge fund manager put all his risk on right away.
By the April, Kyle and other investment managers who invested with him were around 60% net long equities. A couple of months later he started with subprime mortgage shorts. The light bulb went on for him when brainstorming with Alan Fournier (who runs Pennant Capital Management) on Rust Belt’s high concentration of mortgage securitizations where home prices have declined drastically due to its negative jobs growth and net emigrations. The result was launching of a subprime-only fund in mid-September, 2006. Despite Kyle’s fear they’re not going to get their positions on in time, fund got fully invested on day one. In the beginning Kyle had to take anyone that would write them a check. However, more than a decade later he is pretty satisfied with their investor base. He especially values large investors who have experience and knowledge and their feedbacks, of course. As he says, they were and still are operating out of fear of losing while institutionalizing risk management particularly and having risk function framed by how much can be lost. Being opinionated and thoughtful is important when it comes to risk management. Of course, keeping a balance between both shorts and longs is crucial for how they are managing money. By building ”positions with asymmetry through optionality” as Kyle says, the downside is defined even if they are wrong.
After a great start and the first big trade in 2006/07, came 2008, the global financial crisis and the short sale ban. The turbulent and troublesome year brought a bit of money, while managing volatility on each individual investment and the portfolio was a tough job. The year 2009 saw things going similarly. Since launching this was their only losing year and he explains the reasons why.
Besides his main fund, he also had SPV like Japan-only fund which was investor driven. They used hedge overlay strategy for an investor’s entire portfolio, and also ran mortgage books of a few asset management firms. Although Kyle had dogmatic views on Japan, they haven’t lost a huge amount of money there, as he, later on, explains while answering the question on the thesis in Japan, and how did they structure it. He also discusses “The Japan Trade,” how much dollar/yen will go and what is the reason for him to go the other way and buy Japan – or in other words, he tells us why he is buying subprime debts instead of shorting them (what he’s done in the first place). Right now, Japan is his (their) single focus. The country’s debt is the same as U.S. debt. However, it has a bit more than a third of U.S. population. Since we are about to witness what will happen to the indebted Western society, Kyle assumes how Japan’s scenario will play out. Among other things, he mentions financial crisis, war, nationalism, etc. After all, he believes that “there’s been a trade war with China since 2001.”
However, besides Japanese yen purchasing power, which is the biggest bubble right now, the things are not bright in Europe either, especially in Spain and Italy. Although Kyle tried his luck with the Swiss trade being the first person to buy CDS on Switzerland and also Greek CDS, nowadays he doesn’t do much on the old continent, except waiting to see wiping out of Greek official sector debt again, as well as the solution of youth unemployment issue in Italy and Spain since rates are pretty high (above 30%).
After giving his opinion on what’s up with global inflation, he answered on what he is doing differently nowadays when it comes to short sales and what was the worst trade he’s ever done. Steven wraps up the interview by asking Kyle about ways he “unplugs” himself from the tumultuous world around him.