The (Alpha) Discovery Channel
Cocktail parties, oil markets, and why China resembles Bismarck’s Germany as it continues to exert its economic influence – in conversation with Massar Capital’s Marwan Younes…
2020 has been the year of multiple market events to keep any global macro manager busy. It all started back in January with the assassination of Iran’s General Soleimani, swiftly followed by the calamity of Covid-19, the unprecedented pace of developing – and announcing – multiple vaccines, and the US elections, from which the dust has only just started to settle.
As if that wasn’t enough, we are now all watching closely the final stages of UK/EU Brexit negotiations that will either result in a fair deal or none at all.
This has been a year of remarkable dimensions and has tested the limits of portfolio managers’ imaginations. One manager that has taken stock of the situation, and challenge the expected market norms, is New York-based Massar Capital.
Massar blends a discretionary global macro approach with advanced data analytics to generate risk-adjusted returns uncorrelated to major market indices and other hedge fund strategies.
Navigating unknown territory
“We had a bearish position in oil towards the end of January,” says Younes. “We analysed what the impact of a global lockdown would have as the virus moved east to west and to me, what happened to the oil price in April was more a failure of imagination than a miss in the S&D forecast.
“The global oil market, in aggregate, produces and consumes approximately 100 million barrels a day, so if there’s a 1 million barrel per day decrease in oil consumption, that is equivalent to just 1 per cent of total output. To put this in context, a 1 per cent delta would historically be a massive change in the balance sheet – the equivalent of the entire Libyan output currently offline. However, in March and April, demand fell roughly by 25 million barrels a day so your delta was no longer 1 per cent, it was more like 20 to 25 per cent, which we’ve never seen before. Not even during the Second World War.”
An oil analyst studying their spreadsheet to work out what the price would be if demand fell by 1 per cent, or even 10 per cent, had no benchmark to tell them what the price would be if demand fell 25 per cent because it had never happened. It was Terra Incognito.
“We had the data but also the intellectual flexibility to interpret it in such a way that we could surmise that lack of demand would shatter existing storage constraints. That need to store huge amounts of oil means you have to collapse the front price versus the back. You have to have massive contango in order to incentivise immediate short-term storage; 25 million barrels a day is a lot.
“All said and done, it was a failure of imagination among some hedge funds to think through what such an event could do to the oil price,” asserts Younes.
Interestingly, Younes refers to the Soleimani situation back in January which presented an immediate trading opportunity on the back of simply watching TV. At the time, he was watching a Middle East channel (Al-Arabiya), during which a news flash popped up announcing the attack. It was, he says, some 40 minutes before Bloomberg and other major news channels caught wind of the fact.
“Even when the news did come out there was hardly any movement in oil markets. We bought oil futures right away. It was unbelievable to me that there was so little price movement; so much so, that I wondered if the news reports were accurate,” recalls Younes.
Information as a commodity
Technology lies at the heart of Massar’s research process and is predicated on processing data in a smarter way, combining it with market domain knowledge. As part of its research process, Massar builds tailor-made data collection engines specific to the structure of each data set.
The data is then tickerised into a uniform categorisation system and used to generate supply/demand estimates, seasonal trends, intraday patterns, market positioning reports, data release estimates, weather predictions and macroeconomic analysis.
In Younes’s view, information has become commoditised.
“As a hedge fund, I don’t have better information on oil fundamentals than an oil major or a merchant. Another advantage I don’t have available to me is a very long-term investment horizon like a pension plan, who can buy an asset and hold it for years to monetise its value. My constraints mean I have a much shorter timeframe.
“But the one advantage I do have is the flexibility to decide when to trade and when not to trade. If you’re an oil merchant, you have to be in the market as an intermediary and a counterparty to other participants. A pension plan has defined liabilities that they are required to match. It’s not like we have superior information, instead our edge stems from flexibility in deploying capital, and adapting our trading in response to new information based on the expected risk/reward,” says Younes.
There are, however, areas where Massar Capital believes it has an information edge.
In particular, Younes cites his Middle Eastern roots and his understanding of ongoing developments in the region, as well as his prior experience trading index products, which have a huge number of futures contracts that need to roll from one month to the next:
“I used to manage these types of structured products when I worked on the commodities index desk at Morgan Stanley, and there are valuable nuances in the mechanics involved that we have an edge in, compared to others. But that edge is only made possible when there’s a stressed environment and there’s a mismatch in liquidity between buyers and sellers, as occurred in April 2020 with the USO roll.”
Casting the net
Like any good global macro manager, Massar Capital takes a top-down view of the world to trade securities over the short term – as referenced above with the oil moves this year – but there is also an emphasis on looking at longer term macro developments.
And while the firm uses technology to build smart insights from data to trade across 70 global markets, Younes does not, in any way, suggest they know what the markets are doing. He is quick to point out that he is not the guy at the cocktail party holding court, recounting a tall tale to a swooning audience.
“There’s a weird tension between our approach to markets, and the marketing challenges involved in attracting investors,” he says.
“We are wired as human beings to enjoy hearing stories – storytelling is in fact key in how we frame our reality and expectations for the future.
“When you walk into a meeting room, investors are eager to hear what your latest great trade idea is, framed as a story of what will happen in the future. But the challenge for us is that building a diversified portfolio of many small trades that are leveraging various idiosyncratic inefficiencies does not make for a great story.
“Telling people you have no idea what will happen in the future certainly doesn’t make for the most interesting cocktail party conversation.. But at Massar Capital, we’re not oracles trying to divine the future – we’re more like fishermen casting our net wide.”
In many respects, volatility is itself a function of the market itself not knowing where things are going. All any good fund manager can do is adapt to the incoming information and dare to consider the big idea, even if it has never happened before.
Two good examples of this are Brexit back in June 2016 and the US election in November 2016; both of which proved to be profitable events for Younes.
The firm couldn’t possibly know Brexit was going to happen. But what was clear to them was that while the polls were pointing to a coin flip, the market was very bullishly positioned one way; no Brexit.
This was a form of anchoring bias where people rely too heavily on the first piece of information they see and it influences their ability to look objectively at new information as it comes in. This makes it hard to conceive of something that has never happened before; whether that be a 25 per cent decline in oil consumption or a decision by the UK populace to vacate Europe after 40-plus years.
“We bet on a Brexit outcome in the June 2016 UK referendum, not because we thought it was the likely outcome, but because it was clear that there was a divergence in pricing; despite polls essentially reflecting a coin-toss probability, the market was overwhelmingly betting on a “remain” outcome - if the latter had come to pass, we would have lost a lot less than we made. We were long fixed income and on aggregate, short equities, and sold markets that hadn’t reacted quickly enough such as soybeans. It was a basket of different trades we felt were mispriced.
“Similarly, prior to the 2016 Trump election victory, we spent a lot of time looking at different polls to understand the different biases they were subject to. It was intuitive for us to think about which states Trump would likely win and as a result we had a higher probability than the market that he would win. The market give him a 5 per cent shot and I think the Princeton election forecast had him at 1 per cent to win, but our probability was closer to 35 per cent,” Younes explains.
When two tribes…
As part of its longer-term macro outlook, Massar Capital is paying close attention to the shifting economic dynamics between the US and China, with tensions still high as one superpower watches its influence decline relative to the other.
Younes is of the view that what we are seeing right now is a progressive dismantling of the framework of international relations that emerged following WW2, where institutions such as the World Bank were effectively a function of American power and hegemony.
“The US was able to underwrite, economically, the re-integration of Europe via the Marshall Plan, and politically by pushing for the creating of a bulwark in the face of the Eastern Bloc. More recently, however, the relative decline of the US on the world stage has impaired its ability to support the old international older, with the rise of inter-European antagonisms a reflection of that decline,” he says.
Right now, one of the most challenging questions macro managers have to consider is how the US dollar will fare versus the RMB over the coming years.
“Our view is that the relationship between the US and China has many parallels to the relationship between the UK and Germany prior to the First World War. You had a dominant power, the UK, that essentially controlled trade routes, which following the Industrial Revolution had built the world leading manufacturing base, but had undergone a process of de-industrialisation given Germany’s lower cost of production,” says Younes.
English factories had been moving to Germany for two or three decades leading up to the war, following the unification under Bismarck of what was essentially a mosaic of small individual states.
“In a similar way, China was a dormant giant that benefited from a strong leadership that started pushing aggressively for industrialisation and economic growth. When Germany became economically more powerful, it ran into the international constraints established by the old world colonial blocks that constrained German access to new markets.
“Today, the rise in US-Chinese tension reflects China facing similar constraints imposed by the multi-lateral Western order, but we think there is a structural tailwind for the RMB to continue appreciating over the next few years,” concludes Younes.
The ongoing US/China relationship certainly should make for compelling viewing.