From Institutional Investor:
Hedge Fund Manager John Burbank’s Investment Alchemy
"The head of San Francisco–based hedge fund firm Passport Capital has figured out how to turn risk management into an alpha strategy."
HEDGE FUND MANAGER John Burbank III has made a career of anticipating how headline events and political edicts might affect the markets, and that’s why he was on something of a tirade the afternoon of September 19. Like every investment professional, the 49-year-old founder and CIO of Passport Capital in San Francisco had watched U.S. Federal Reserve chairman Ben Bernanke deliver a speech the day before in which he made the surprise announcement that the Fed would not start tapering its quantitative easing program yet.
“It’s cowardly,” Burbank said of the decision, holding court before 30 of his portfolio managers and analysts, assembled in the firm’s conference room for a macro investing meeting. Passport’s offices are on the 22nd floor of the office tower at One Market Plaza, on the Embarcadero, and behind Burbank a wall of picture windows overlooked San Francisco Bay and catamarans racing in the America’s Cup. The yachting races had been scheduled to end that week, but unsettled winds had delayed the final runs at about the same time that Bernanke announced that he was putting off the taper because of the unsettled economy. Burbank had expected the Fed to reduce its $85 billion in monthly bond purchases by about $10 billion; now, he said, he feared the U.S. was becoming overly reliant on quantitative easing as the only way to prop up the economy.
As a global macro hedge fund manager, Burbank is in the business of anticipating big shifts in the economic, political and social factors that move markets. He is the first to acknowledge that on a number of occasions he has made a market prediction that turned out to be accurate, but lost money by trading on the idea too early. This could have been one of those occasions — and it could have been disastrous for Passport’s portfolios.
Burly and bearded, Burbank typically wears a fleece vest to ward off San Francisco’s year-round chill and looks like an adventurer who can handle narrow escapes. But in the conference room, he was just in shirtsleeves, talking in his stentorian voice about how the firm had managed to evade a dangerous financial situation by cutting back on its short positions in emerging markets earlier in the month. Whereas a taper would have been likely to drive emerging-markets prices down and be good for short-sellers, the continuation of the Fed’s program to buy U.S. Treasuries was more apt to boost stock prices around the world.
At the conference table Tim Garry, the bespectacled young head of Passport’s quantitative division and risk committee, nodded as Burbank spoke. Garry, 34, has a deceptively calm demeanor for someone who spends his days looking for scary things going on in the markets; he practices meditation and says it helps him deal with stress. He tends to do more listening than talking when Burbank is in the room. But it was Garry and his team — four quants and several risk programmers — who decided in late August that it was time for Passport to trim its emerging-markets shorts. Growth figures from China were better than expected, and they had detected a condition they described to Burbank and the firm’s other portfolio managers in quantspeak: increased trading momentum in high-beta stocks. Burbank didn’t always understand the importance of making daily calculations of beta, or correlation to market moves, but he does now.
Since Garry’s arrival at Passport from State Street Global Advisors nearly six years ago, the firm has evolved its investment strategy into a unique blend of global macro themes, bottom-up stock picking and quantitative risk analysis. And though there have been a number of speed bumps along the way, in 2013 Passport’s portfolio managers showed that they can use risk management not just to gauge danger but to boost their returns.
“Five years ago we would have said the way we handle risk is to know our companies better than anyone else does,” says Burbank, whose firm manages nearly $4 billion in assets. “But if you don’t understand, for example, apparent liquidity versus the liquidity you see by looking at volumes and whether the volume is coming from high frequency trading or real money, you don’t understand your liquidity exposure.”
Burbank set out to hire a quant in 2007 because he saw algorithmic trading as yet another big shift in the market and he wanted to tap into it. He and Garry began employing algorithms to identify risk factors they could use to trade with more-exacting attention to position size, timing and hedging. Burbank identifies big-picture investment themes. The firm’s fundamental portfolio managers pick assets — mostly equities — that fit into the themes. The quant team tells the others how to size positions, and when to get in and out, based on day-to-day market movements and risks....MUCH MORE
