Confessions I: Baptism of Fire

Hey Guys! Hugh Hendry.

As I think most of you know, I was responsible for a global macro hedge fund. I ran it out of London between the years 2002 and 2017. So, 15 years, eclectic by name, eclectic by nature; uncorrelated returns. Was it the best macro hedge fund ever? No. Was it entertaining? Was it uncorrelated? Yes. Did it correlate with anything in the world? No, it didn’t. It was unique.

Regardless, I’m hoping that you will want to hear my story. This is the story of someone growing up with investors, with responsibility to write a letter each month, a letter of culpability which typically began with a mea culpa: I’m really sorry! I had this great idea. But it was… we were just…I was too God damn early.

So, these are like my diaries, or my confessions, I want you to think of them as a master class and I hope you can be persuaded to stay tuned as we go through these monthlies, we’re going to shoot about 10 minutes. I fear it’s going to be deadly dull, but there were just so many things happening in my life that I got to share it with you. You know, the curse was too many interesting things, too many great anecdotes, so hopefully we can bring out some of these anecdotes because this was such an amazing time.

Crispin Odey. I was working within the confines of his partnership; I was a partner at Odey Asset Management. And Crispin had for many years been re-establishing his immense credibility after the debacle a decade before when he had got trapped in a position in British gilts, I don’t want to get stuck on that. But he could see that so many years later, he was very much on the cusp of being forgiven, if you will, and assets were beginning to grow again.

But we were managing a very, very small amount of money compared to where the world accords genius today. And we had very, very eccentric ideas. And Crispin was loath to let me into the VIP room, he could see something of his character, perhaps, something of his madness in me, and so he hesitated to let me loose with the management of a hedge fund. I remember he said: There’s no handbook. It’s like driving a sports car and, for sure you want to drive really, really fast and so he’s really worried to give me the keys to his Ferrari; to the damage that I could do, not only to myself but of course to his reputation, that he had worked so fastidiously on trying to repair. So, that was the kind of backdrop to my apprentice as a hedge fund manager.

Why don’t I plunge straight in because for the first month, and I’d ask you again to remember that most hedge funds fail in the first year. That’s the thing that’s uppermost in your mind. Most hedge funds fail in the first year, it’s kind of like a restaurant, it’s why a good restaurant, a restaurant that endures is a restaurant that typically makes a lot of money. But in the month of October 2002, I lost 4.8%, I MEAN 4.8pc! I’m going to say it again, I lost 4.8% when the markets were up, 8%, WTF!!??

The benchmark we used back then was the FTSE all share, which is an equity index. Remember it was like a private client vehicle. Back in the day: no institutional investors. Family offices were the only investors. And it had been a great month for equities. There is scant detail in my report. You can read it at your leisure as it’s found on IG site but the letter doesn’t say anything in terms of marks out of 10, it was very much a one out of 10 month. Would you believe I was almost 102% gross long? My shorts were less than 1%. So, I was 101% net long. The market was up 8% and Hendry was down the best part of 5%.

There’s no mention to whatever it was that was destroying me. The only hint is in the opening sentence when I say the European Central Bank, got it wrong. How often have you heard me say that? It began in my first letter. The ECB had last cut interest rates almost a year before I had launched this fund, when it had taken rates down from 3.75% and they had cut rates by 1.5%. They got quite aggressive by the tail end of 2001 with a succession of almost monthly cuts, but from November 2001 nothing, absolutely nothing. Whereas the Fed have been very proactive.

And so, I imagine when I see those returns, I must imagine because it’s not in this report, but I imagine, and forgive me as I’m moving around a lot, let me get closer. I imagine that I had a very large interest rate futures position, which was bleeding with time decay as the bureaucrats at the ECB dithered, I was anticipating that we would get a rate cut, but no rate cut, no P&L, just losses on this particular early adventure.

And of course, I really lived a life rich in irony because I think we were, it was December, just 2 months later when we got the next cut, equity markets in October were clearly anticipating events in December; funny that…the margin for error can be very fine.

We gave a stock insight or a trade insight each month to try and explain the nature of our thinking; to try and be transparent. This month it was Yellow Pages, these classified directory books, and when I look at the top long holdings, we were pretty much I guess let’s call it the Ben Graham – puffing on cigars – strategy. And with the last embers of the great TMT crash, we were buying stocks which had fallen 80 or 90%.

The one we made reference to in the report was in ENIRO and I’ve checked before doing this and ENIRO is still listed today. That’s not to say much. You can see that it’s had a really, tough time. But back then, it had been a darling, back then it was going to use this cash flow and it was going to be an internet platform. It didn’t work out. It wasted a huge amount of money on an ill-advised speculation in Germany, but it closed it and you still had boring old Yellow Pages – a utility cash generating monster.

This was before Google when we all had these big thick directory books. So, if you’re old, like me, you remember those days. We were the original venture capitalist…with the cash flow, you take the free cash flow so, you know you’re taking care of any movements in working capital, you’re looking after the maintenance capex, you’re trying to normalize capex to depreciation and you’re figuring, trying to figure out the cash flow that you could extract from the business, it would be attributed to you as the equity investor, having paid out the stakeholders: tax to the government and interest payments to the banks and the debt holders. Remember this is cash flow after you’ve maintained the nature of the business intact and you haven’t neglected the creditors of the business, that’s why we look at working capital, and after expressing wherever that cash flow figure was, by the market capitalization. We were attracted by this 10% ratio.

But I wanted my ideas expressed into many iterations. Because I was constantly shuffling the book, we were constantly, you know, during a day we were constantly trading. You had to write, I’m getting excited here, and getting sentimental, but my trading book, this handwritten ledger was really like a Charles Dickens story, and I want to say we wrote by hand at least about 20 pages of trades every day. A frenetic daily pursuit of curiosity.

If you remember Danny Boyle made a movie about it. About the climber in some US state and he gets his arm trapped by a boulder, and he’s on his own, and he can’t free the arm and he’s gonna die. Unless he gets his arm out first and spoiler alert but he succeeds by cutting his arm off! And, understandably, having only two arms and two legs… these two arms… he procrastinates like you would: “Do I really want to cut this off? Sure? Hmmm… Can I afford not to? Shit! I’m going to die if I don’t.” Back and forth, you know, back and forward. And so, for me, I didn’t want to have just two positions, and have to procrastinate all day with danger looming everywhere, for me I needed to make incisive decisions and 100 positions were better than 2. One hundred trades kept me focused.

And I was buying and selling them every day to gauge sentiment and to gauge where I was in terms of my understanding. Remember, I was always looking at the charts. The charts were like sheet music, and they were conjuring up images. And then I would have this small pool of talented individuals who would triangulate and attempt to corroborate and legitimize what I was feeling in these chart expressions. And hence they came back to me with the very high FREE cash flow figures to rationalise what I could see in the charts. However, and to wind up, ENIRO was a dying business and my clients’ money would have been better invested elsewhere. It was very much a distraction from my interest rates, which were the BIG story, we will discuss that for sure next time.

I started the fund pretty much at the lows for European equities. But like gold, and we’re going to talk about gold in the next couple of episodes, but gold equities were very, very volatile and they kind of went sideways for the next three or four months, just like European equities, driving us all nuts. So, it was a challenging baptism of fire. But between the end of 2002 and the middle of 2005, European stocks almost doubled, they kind of went back to touch their previous high. That’s good. We found a stock and it doubled. But we should have done much better risk and size adjusted.

Did I mention that my son was born that month? And that my son was born with silent reflux. He was a baby who cried every day of that first month. And my wife who cared for him, cried every day, and she wasn’t the crying type, but he just kept crying… And with me down 4.8% and the stock market up 8% well believe me, in that first eventful month, I was crying too.

So, no more tears. If you’re interested, I’m going to do this exercise again. And we’re going to talk about November 2002. Thank you very much, and thank you everyone for listening.

Hugh