Hugh Hendry, the out­spo­ken CIO and co-founder of Eclec­tica, one of the UK's most suc­cess­ful hedge funds dur­ing the last 4 years, and in par­tic­u­lar the last 2 years, appears in a full length inter­view, speak­ing on a vari­ety of issues, includ­ing his thoughts on con­trar­i­an­ism, quan­ti­ta­tive eas­ing, defla­tion vs. infla­tion, his out­look for the mar­ket, and future of the hedge fund industry.

As usual, Hendry is both enlight­en­ing, and con­tro­ver­sial, and his remark­able accu­racy about the nature of the mar­ket and course dur­ing the last year make him worth lis­ten­ing to. Click play to view:

Part 1: The Eclec­tica co-founder explains why he is stick­ing to his guns despite hav­ing 'my tail between my legs' after the recent bank­ing sec­tor rally, and why the dol­lar could approach par­ity with the euro.

Part 2 : The out­spo­ken hedge fund man­ager argues that the major­ity of his peers 'have no future', and explains his fear that tighter finan­cial reg­u­la­tion will mean two decades of defla­tion in the sec­ond of a two part series.

Here is a com­plete tran­script of the interview:

We have had an unprece­dented period, unprece­dented. Its never hap­pened before. It's never been the case that the stock mar­ket has gone up almost 30 times in just one move­ment. What I'm say­ing to you is that the Dow Jones in 1975 was around 590 points, and in 2007, we got to around 14,200 points. I round down, you know. That's never ever hap­pened. That is unprece­dented pros­per­ity. And the peo­ple who gained the most from that, are the fund man­agers, like me. Except, I'm aware of it. A lot of peo­ple are just not aware of it, to be lucky to be in the right place at the right time. But as you know, equity mar­kets have done noth­ing for the past ten years, and if you look at the exam­ple of Japan, you're stretch­ing 25 years, and you're see­ing lows that we recorded in the 1980s. And I think that's com­ing, that's encroach­ing on our path.

When I go the major cities of the world, I say, hey, "Where do the fund man­agers live?" "Where do they work?" I want to short peo­ple like me; I'm very fear­ful about my profession's career. So to lay it off, I want to short these guys. "Who has the biggest port­fo­lio of assets?" 'cause all assets are com­ing down, com­ing down. So, you're going to go from being the luck­i­est and the cho­sen, to being the unluck­i­est and the reviled. So, fund man­age­ment fran­chises, insur­ance com­pa­nies; I don't care if you're com­pos­ite or if you're life. I worry about the opac­ity of it. The abil­ity to see in and the abil­ity to test the value of their port­fo­lio. I worry about what's this mark-to-market. The banks have had the dis­ci­pline of it, and we've seen what that's done to their share price. The insur­ance com­pa­nies haven't. That's my premise, the same thing applies with Gen­eral Elec­tric, GE, GE Cap­i­tal. That's a huge invest­ment man­ager: $660-billion in assets and they're com­ing down, but they've only marked 2% of the assets to mar­ket. To my mind, if you gave that busi­ness an appro­pri­ate hair cut, it would sug­gest that that busi­ness is insol­vent, and yet its deemed to be one of the most credit wor­thy com­pa­nies in the world today. Noth­ing makes sense today.

Will the Dol­lar Main­tain its Strength?

What­ever I say now, no one will under­stand, so with that caveat, I don't say that as a con­ceited man, I'm not talk­ing down to any­one, its just a dif­fi­cult the­ory, nev­er­the­less its a the­ory pos­tu­lated by one of the great econ­o­mists of the twen­ti­eth cen­tury, Irv­ing Fisher, and its [the kind] along the lines of para­dox of thrift. And what's hap­pen­ing is that, or what's hap­pened again in Amer­ica is that like every­one else we took on too much debt, and at its peak we had $53-trillion, think about that, that's a lot of zeroes, $53-trillion of debt out­stand­ing. Peo­ple went crazy, they had these lia­bil­i­ties and they hoped that on [the other] this side, they had $53-trillion of assets, and indeed, three years ago, they prob­a­bly had $80-trillion of assets, and they were look­ing kind of funky.

The prob­lem is the assets, house prices have fallen 25% in the US, that's a big hair­cut, equity prices, they've fallen 50–60%, that's a huge hair­cut. Com­mod­ity prices, they're down 30%-40%-45%, that's a huge hair­cut. Sud­denly, you're find­ing that as you come to cre­ate dol­lars [con­vert assets in to cash], because you own things and you sell things, you're get­ting less dol­lars. So what I want to tell you is that there is a scarcity of cash, there is a scarcity of dol­lars, and that sounds absurd, because here we are today, and they're announc­ing they're bank bailout scheme, and they're talk­ing about $50–100-billion of gov­ern­ment money and lever­ag­ing it, they can't break the link with the past, they want to lever­age it up to half a tril­lion dol­lars. That's why I want to say to you...if you think about all of the government's announce­ments in the US...its small change out of $53-trillion of debt. That's why I say to you, the econ­omy will weaken, because they're not being heroic enough, actu­ally they believe the con­sen­sus that if you print enough money you cre­ate inflation.

Every one believes in Fried­man, every­one is being slow to deal with the fact that there's this legacy of $53-trillion and its like a heavy object, just press­ing the life out of the entre­pre­neur­ial spirit, and there­fore keep­ing the econ­omy down. Look, that's my pre­sump­tion, and under that pre­sump­tion, the dol­lar should be strong, and the dol­lar has been strong. Its been a frus­tra­tion to the many peo­ple, the strength of the dol­lar. Now in the last two weeks with the quan­ti­ta­tive eas­ing announce­ment, the dol­lar has weak­ened, but I think in the process of the next month or two, you will see the dol­lar bot­tom and then go on, and I wouldn't be sur­prised if we got close to par­ity vis-a-vis the Euro within the months and years to come.

The Para­dox of Con­trar­i­an­ism

Expert after expert lines up to tell you that the future's infla­tion­ary and you should be sell­ing con­ven­tional gov­ern­ment bonds. Gov­ern­ment bonds have been in an uptrend, so that is an intel­lec­tual con­ceit which is not sup­ported by the price trend, and there­fore I am invested in gov­ern­ment bonds, I'm trend fol­low­ing, but I'm con­trar­ian. The dol­lar over the course of the last 3 years has risen. Every invest­ment coun­sel­lor will advise you to sell dol­lars. I will advise you to buy. I pur­su­ing the trend, yet I'm being con­trar­ian. You see how it works out? So first prin­ci­pals are 1) iden­ti­fy­ing the idea, the oppor­tu­nity, and then 2) test­ing it against the mar­ket. I got a com­puter screen on the wall and I say to my kids, Mir­ror, Mir­ror on the wall, who's the pret­ti­est of them all? When I'm stuck, I ask the mar­ket. And if the market's trend­ing higher, then it says I should be try­ing to buy them, and if its trend­ing down, I should be try­ing to avoid it.

What peo­ple for­get is that a suc­cess­ful con­trar­ian is only con­trar­ian 20% of the time. Less than 20% of the time do you ever dare to go against the trend. So most of the time we are pur­su­ing trend. And yet, being contrarian.

A Bear Mar­ket Rally — A Test of Faith?

Last March, my hedge fund, we lost 16% per­cent. That's a hefty decline. The pre­ced­ing two months, we made 25% and then we lost 16%, then we lost money in April and May, and June. I have to say, I was quite sui­ci­dal, but remem­ber, for the year we made 32%.

So, I tell you, we could sum it up, the stock mar­ket was cap­tured by the bib­li­cal story. It was St. Peter or St. Paul, but he was the most fer­vent believer. He's seen the almight­i­est Jesus Christ, he's there in the gar­den, and he says's "You're the man!" And Jesus says, "What are you talk­ing about?" Before the cock crows three times you'll have rejected me not once, but three times. And he says "Impossible!"

That's what stock mar­kets are all about. Here I am with my defla­tion­ary notions of what might hap­pen. Here I am believ­ing that there's no intrin­sic value in bank­ing stocks, and the cock's crow­ing and its kind of "Have I changed my mind?" I haven't. Have I changed my mind? Mar­kets are set up to take you away from the purity and the sanc­tity of sen­si­ble think­ing. And because of that I spend my time talk­ing to you. I spend my time; I'm just back from China, I hug trees, I do any­thing but sit in my office and watch the port­fo­lio go like that [he makes a flut­ter­ing motion].

Peo­ple claim that I get very cocky. I read some of the cor­re­spon­dence that goes on when they've seen me on tele­vi­sion and they were say­ing after my last appear­ance, I really was a bit cocky, so you know what? Yeah, I get my head handed to me by these peo­ple. I sober up, you're quite right, It's a les­son that has to be relearnt over and over again, that no one per­son is big­ger than the mar­ket, that no one per­son has a divine right to be right. There, I hear you, I hear you [motion­ing hand to ear to God].

The hedge fund indus­try in its con­struc­tion, as we know it from like, a year ago or 18 months ago is fin­ished. Its fin­ished, I think, yeah. And it was a dis­fig­u­ra­tion of the spirit of hedge funds. Hedge funds in the 1970s, there weren't many, they were kind of kooky, kind of mav­er­ick, eclec­tic peo­ple. The kind of thing that I've tried to emu­late, prob­a­bly with less suc­cess. And because of all those char­ac­ter­is­tics, you can never give them much mind. That's why they're alter­na­tive. You kind of respected them, but it was just too much, they were just too mad. And then you spent of the rest of your life wish­ing you'd given them more money. I think we go back to that envi­ron­ment. There are too many hedge fund man­agers, and not enough kooky brave inde­pen­dent think­ing spir­its out there like them. I  think the mech­a­nism that will take us there, is all these non-kooky indi­vid­u­als los­ing money. The aver­age hedge fund lost money last year. 

The aver­age hedge fund has imposed gates and locked their clients in. They're fin­ished. They're fin­ished. There are hedge funds out there and they have gated, what I mean is they're deny­ing their clients with­draw­ing their money. They're writ­ing to their clients, the good news, is that we've made money in Jan­u­ary, and Feb­ru­ary, we're mak­ing money in March. Absolute tripe! Okay, you have not made a penny, when you're deny­ing the clients their money. So these are peo­ple who have no future, who are walk­ing around pre­tend­ing that they have a future. That time will catch up with them. Lastly, the point I want to make to you is that the com­mon thread of these funds like Mad­off, which have failed, and the exam­ple of one unveiled last week in Lon­don, this Global Macro fund, the com­mon­al­ity is the very low volatil­ity. These are funds that made money in a rea­son­able con­sis­tent man­ner; it was almost lin­ear, lin­ear, lin­ear, year after year after year. I never believe in lin­ear progression.

I believe in volatil­ity and the crazi­ness of life as we search for the uncer­tain future. My returns are volatile. Our only thing is from a cal­en­dar year of risk, we never lose much money. One year, we lost 3% and it still gob­bles me that we lost 3%., not 33%. On a month-by-month basis it can be crazy. So what we found, we found a con­ceit in that as a soci­ety, we have abol­ished the busi­ness cycle so rather than going up and down with the econ­omy. Gor­don Brown told us he had abol­ished boom bust so that we have a lin­ear pro­gres­sion. Bernie Mad­off was a lin­ear pro­gres­sion. We could make money with­out doubts, hence we ele­vated the hedge fund com­mu­nity into the pre­mier divi­sion. That was all a mis­take. And, cycli­cal­ity is re-imposing itself, and I'm just warn­ing you that cycli­cal­ity, once unleashed, isn't nec­es­sar­ily 2–3 years, it's 20–30 years in its for­ma­tion. 

Can the Reg­u­la­tors Save Us?

This is a big fear, I think its a legit­i­mate fear. The fear is that there's now an open out­cry, by soci­ety at large as to the remu­ner­a­tion, and the risk tak­ing that was nec­es­sary over the last few years by the finan­cial sec­tor. And, because soci­ety has been called in to res­cue the finan­cial sec­tor is demand­ing its pound of flesh. And I don't take issue with that, I accept that as the nat­ural course of events. But, there is also this law of unin­tended con­se­quences, so we look at say the British prop­erty mar­ket, and it now seems crazy. One could get up to 5 times your salary to pur­chase your house. And now we might impose a low amount of lever­age of 2–3 times. The prob­lem with that is that even with the decline in hous­ing prices, no one could afford a house price if you bring down the... so that the credit lever­age was only a func­tion of asset prices being very high, and there­fore you had to over­arch in order to gain a com­pet­i­tive return as a spec­u­la­tor or just get on the hous­ing mat­ter as a reg­u­lar per­son. The com­mon­al­ity between those two trans­ac­tion is asset prices. They were too high.

So the regulator's com­ing in and try­ing to bring down lever­age in the mar­ket, and they are after hedge funds. I don't know why... I do know why — They are rich and suc­cess­ful. Fair game — bring down their lever­age and bring down the lever­age of home buy­ers, prospec­tive house buy­ers. The prob­lem with that is it bakes in the notion that house prices and assets will spend the next 20 years deflat­ing, under this more sober and con­ser­v­a­tive environment.

The Hedge Fund as Invest­ment Lab­o­ra­tory

The last two weeks, noth­ing has been fun, because all the port­fo­lios, they all go the same way. There's no prod­uct diver­si­fi­ca­tion, so one fund's doing well another one's not doing well. I don't under­stand that word, super­mar­ket, and the dif­fi­cult thing right now is we have no con­fir­ma­tion for our ideas, we're tak­ing a past­ing. Three weeks ago, we were 11 or 12 points ahead of the index and today, that's prob­a­bly now 3 or 4. At the same time, we were up 10–11 points in absolute terms in the hedge fund and that's come down to 4. So every­where I look now, my tail's between my legs. But my mes­sage is the same. All my money's in my hedge fund. The hedge fund, I believe, is as supe­rior prod­uct, and if you've got that min­i­mal mar­ket, those pounds, euros, and dol­lars, I, we've placed within the hedge fund; we use the hedge fund as a lab­o­ra­tory, a test pad. We incu­bate ideas and once they take root and they gain legit­i­macy, and once we start to make money on the blasted things, we can then take lit­tle trans­plants and put in to our long [term] hold­ings. Its a bet­ter way, I hope its har­mo­nious and they can live together, one ben­e­fits from the other.

What is Eclectica's Invest­ment Process?

We are very much free thinkers at the macro level. We, through our col­lec­tive efforts in travel, in terms of infor­ma­tion sources, in the way we look at things — you know we're trad­ing cur­ren­cies, we're trad­ing com­mod­ity futures, we're trad­ing gov­ern­ment bonds, we've got fin­gers in the all of the pies, so when we come to look at an equity port­fo­lio, we drill down all that wealth of expe­ri­ence, to try and deter­mine the most likely path of the econ­omy and the stocks that ben­e­fit from it. Our port­fo­lios have under­gone a dra­matic change. Up until July of last year, we had up to three quar­ters of the port­fo­lios invested in com­modi­ties, and the major­ity of that was agri­cul­tural com­modi­ties. But then, some­thing hap­pened. This defla­tion shock struck, and it hit, our cri­sis, and after three or four more months it hit the two year trend, and our port­fo­lio changed. And today our port­fo­lio is defen­sive. Tobacco, health care,  util­i­ties, sta­ples. In the last three weeks that's come under enor­mous down­side pres­sure. But as I say to you its three weeks and we need monthly obser­va­tions. Now if that down­side pres­sure were to con­tinue, our port­fo­lio would change again.

My ide­o­log­i­cal pref­er­ence is that that won't hap­pen, but I have to remain intel­lec­tu­ally robust to change my port­fo­lio if it does need to. As I say to you, it's not a process of three weeks or four weeks, we're not high inten­sity traders. New world, new price. New trend, new port­fo­lio. That's our mantra, but today, we're still from the view that the econ­omy is under duress and there­fore we're still stick­ing to the low end of these trends, close to trends in the defen­sive stocks. Time will tell if we have to change them. 

Fund Man­age­ment With­out Con­vic­tion

Con­vic­tion has got no role in my oper­a­tion. There are con­cerns about Eclec­tica, or about, me... The con­cern is that you see me every­where, you see me on CNBC, I do Bloomberg in the US, I'm on the BBC — heav­ens, I made a doc­u­men­tary for Chan­nel Four last year, and its all high falutin stuff and it all gives the impres­sion that there's all of this con­ceit and arro­gance — Hey, you're tak­ing on, I am Hugh Hendry tak­ing on the mar­ket, but its actu­ally dri­ven by the reverse. I actu­ally very fear­ful of hav­ing ideas that I can artic­u­late and gain your con­vic­tion. I'm very fear­ful of that, and so those first prin­ci­pals that we built up, what we call port­fo­lio man­age­ment prin­ci­ples. — we devel­oped a series of rules which are there to con­strain what I can do. So I can only get involved in the port­fo­lios as I said to you when we have the legit­i­macy of a pos­i­tive trend. With­out a pos­tive trend, you can take my con­vic­tion and you can throw it away. You can dis­card it. Con­vic­tion has to mar­ried with dis­ci­pline, and we've always done that, but of course, when you see the odd sound­byte, and I'm going on and pon­tif­i­cat­ing about some­thing, you for­get that if the trend changes, we change the portfolio.

Read more from the author/contributor here.

Comments

3 Responses to “Hugh Hendry: Citywire Interview”

1. Max Says:
   April 11th, 2009 at 12:11 pm

   Who are you kid­ding? The appalling sound qual­ity made this inter­view unuseable.

2. bubba zanetti Says:
   April 13th, 2009 at 10:29 am

   Hugh.... Sui­ci­dal? Don't every say that... not even jok­ing. It's only money, even if it is other people's money.

3. bubba zanetti Says:
   April 13th, 2009 at 10:32 am

   You, Keiser, et al... are all impor­tant voices out there. I don't expect per­fect pre­dic­tions of the future, just a dif­fer­ent voice from the dom­i­nant par­a­digm con­stantly spoon feed to us via cable, radio and internet.