Raj Gupta was Valedictorian of his graduating Class at Princeton University, with a major in engineering and a major in international relations from the Woodrow Wilson School of Public and International Affairs
Raj Gupta was Valedictorian of his graduating Class at Princeton University, with a major in engineering and a major in international relations from the Woodrow Wilson School of Public and International Affairs. He then spent six and a half years at Goldman, Sachs, working on investments in macro trades, risk arbitrage, US equities, distressed debt and bankruptcy situations. In 1990, he co-authored a book, "Controlling the Greenhouse Effect: Five Global Regimes Compared" and in 1993, he wrote another book, "Defense Positioning and Geometry: Rules for a World with Low Force Levels", both published by the Brookings Institution, Washington, D.C. In 1995, he joined Bankers Trust where he managed a G-10 macro and equity proprietary account and in 1997, he became responsible for Omega Advisors' macro investments in the developed country or G-10 arena. In 1999, while continuing as Omega's partner-in-charge of the G-10 Macro Group, Raj formed his own management company which launched Epoch Capital Partners, L.P. and a parallel offshore fund, Epoch Overseas, in May 1999. In October 2000, Raj gave up his responsibilities at Omega to focus entirely on the Epoch funds which now total $165 million in assets under management. Raj Gupta spoke with HFN publisher, Antoine Bernheim, in mid-July 2001.
Profile of Raj Gupta
Born: 1968 in India
Education: Princeton University
Last vacation: Alta, Utah
Last book read: A History of Interest Rates by Homer and
Hobbies: Skiing, Water-skiing, Tennis
Favorite quote: "Obstacles are those frightful things you
see when you take your eyes off your goal" (Henry Ford)
Q. Could you describe your approach to macro investing?
A. We ask a couple of simple questions: the first is whether over the next six to nine months, investors will want to own bonds or stocks or neither or both. The second is whether or not investors have correctly factored in what the growth and inflation outlook will look like, which drives our positioning on the fixed income market. Once we have a strong view on these two questions, we try to figure out which countries or which sectors offer the best bets. We look at the major world bond markets - the U.S., Euroland, Japan, South Korea and the main equity markets. We look at large-cap companies mainly in the US and Japan, a few of the main commodities, primarily base metals and energy, the main exchange rates and a few of the main emerging markets such as Brazil and South Africa.
Q. Could you describe your research process and where you see your edge?
A. We do our own work on all the important economic data that comes out of the main countries. Most of the time, we find that investors and the sell side are very much on top of the story so they can see growth is slowing or accelerating and we all share the same view. But we find with extraordinary consistency that, about once a year, in each of the main three blocks, the U.S., Euroland and Japan, investors are slow to see a change in the business cycle. For example, in late 2000, we saw the dynamics of weakening growth while fixed income markets and investors generally were not expecting much in the way of monetary easing. The other kind of work we do is to try to understand what drives the business cycle which changes quite a lot over the course of a few years. For example, in 1997 and 1998, in order to understand the slowdown that was unfolding, you needed to understand what was happening in half a dozen emerging markets such as Russia, South Africa, Latin America and of course the Asian countries - Malaysia, Indonesia, Singapore, Korea and Hong Kong. Since the summer of 2000, our view has been that the key variable driving the business cycle this time around, unlike 1997 and 1998, is technology stocks and technology sector investment globally. So we currently follow the top eighty technology stocks globally, listen to their conference calls, try to meet their management, try to understand exactly what they are seeing and what they are doing because we think that will determine when the cycle bottoms out. We also speak to policy makers in the three major blocks. While they are obviously not in the business of helping individual funds or investors, occasionally, once every year or every other year, you will have a discussion with them where they have an agenda because they are trying to influence the markets. A lot of investors simply do not have the institutional structure or the mindset to switch from one driver of the business cycle to another. Putting all this information together gives us our best bets and an edge over the competition.
Q. How do you decide on the instruments most suited to implement a trade or play a theme?
A. The first rule we follow is to focus on liquidity. We always try to convert our view into instruments of adequate liquidity where we are reasonably confident that we can be out of the maximum position we take within a half hour of the opening. The second idea is to go where the market is least prepared for the change. That requires an understanding of what the market has priced in essentially every single asset and where the potential lies for the greatest shock. For example, in the Asian crisis, which was a prolonged year and a half affair, the most interesting bet in the beginning was to be short the Asian currencies, the Thai Baht or the Malaysian Ringgit. As the crisis evolved, those currencies became less liquid and we exited those positions. While investors understood what was going on, they failed to see what would follow next. We switched our positions to short the Real, the Rand and the Australian and New Zealand Dollars which is where we felt the next leg of the crisis would carry us to. Finally, we ended up with our largest position being in fixed income in the U.S. and Germany.
Q. What is a typical duration of a trade for you?
A. We accumulate a lot of evidence to formulate our view and it is slow to change. We then wait on the sidelines for the market to give us a good entry point. Sometimes, we are early and we are out within a few days. Sometimes our timing is near perfect and we will add to the trade and stick with it for two to three months.
Q. What factors do you look at to determine whether a trend is about to gain momentum or alternatively reverse itself?
A. First, we try to measure investor positioning. We do a lot of flow-of-funds analysis, we look at capital account flows, foreigners buying or selling domestic assets, mutual fund inflows and outflows, insider buying and selling, how much cash institutions have on hand - all of which gives us a good idea of what is the latent buying or selling potential in the market. The second area, which is a little bit more subjective, is to understand the consensus that is priced into the market. We try to make it as objective as we can by identifying in each market the seven or eight main influential analysts or strategists and following what they are saying. Before a trend starts to accelerate, the best positioning is one where six or seven out of eight influential analysts are looking the other way. If you can find a reason why that consensus is going to be incorrect, and understand why these people have failed to see that - usually an event or a catalyst which is extraneous to their normal mode of thinking - then you have the beginning of a bet that a trend could develop and accelerate. Conversely, when everyone has the same view, you start to realize that you are in the very last inning of the game.
Q. What is normally the structure of your portfolio?
A. We have investments in a number of areas. Typically we do not use leverage and a large part of our portfolio is in cash. Our fixed income positions are often expressed via the purchase of options and thus with only a small amount of capital at risk, say 2 or 3%, we are able to control a large amount of the underlying fixed income instrument, often equivalent to 150% to 200% of our assets. We only buy options; we do not sell options. In equities, partly through index futures, partly through individual equities, subject to the liquidity rules I spoke about, our exposure is typically 20% to 30% of our capital, and would rarely exceed 50% to 60% - these exposure levels are significantly below those for an equity-focused hedge fund. In foreign exchange, our exposure would range from 10% to 60% of capital. Commodities and emerging markets would normally not exceed 10% to 15% of our capital.
Q. What is your approach to managing risk?
A. One of the unique aspects of our style of macro-investing is the ability to control risk. We invest primarily in highly liquid instruments and we try to time our investments as precisely as possible. Every position has a stop which determines how much capital we are willing to lose. We place our stops so that they are not likely to get triggered very quickly -- say only after a few days or a week or two. We add up every single stop to gauge the maximum capital we could lose and that amount generally does not exceed the high single digits as a percentage of capital. Obviously, assuming perfect correlation of all of our investments is too strong an assumption, even if the positions are often based on similar investment ideas. In practice, since 1995, on a quarterly basis, our maximum loss has tended to be around 4%. Often, when a trade does not work, we reduce the positions well before our stops are hit.
Q. Could you tell us about your organization?
A. Our team consists of six people, three of whom focus on the investing side: in addition to me, Dirk Willer who has a PhD from the London School of Economics and was the Russia economist for UBS in 1998. I believe he was the only person on the sell-side with the distinction of correctly predicting that Russia would default within weeks in the summer of 1998. Michael Youssef has been working with me since 1996. He is a CFA, having been an oil and gas analyst at Salomon Smith Barney before he joined me. The other three members of the team assist with investor relations, back office, accounting and technology support. We would like to provide our investors with returns in the high teens - net of all fees - with good risk control and with no correlation to any passive benchmarks. In fact, our returns since inception have had zero correlation with the S&P500. Our goal is not to become a very large fund, but given the markets in which we operate, we certainly have room to invest fairly large amounts of money. u