By Patrick Dunuwila via StockTwits Blog
Legendary hedge fund manager Kyle Bass gained notoriety for accurately predicting and profiting from the 2008 financial crisis. Bass was early to notice a bubble forming in subprime mortgages and in 2007 began purchasing credit default swaps on subprime residential mortgage backed securities. When the housing market finally collapsed Bass made hundreds of millions of dollars from his position. Our partners at Real Vision TV recently sat down with Bass for an interview. Here are some powerful insights from his talk.
1.) “There’s no true science to it, it’s an Art”
This was Bass’ response when being asked about his procedure on finding trade ideas. What he meant by this was that as an experienced investor he’s able to successfully rely on his intuition when scoping out opportunities. Through years of practice and dedication he’
found his own style and method. There isn’t an exact formula behind it, either. Instead, he’s an artist carefully and creatively scanning the world for investment ideas.
2.) He has an incredibly high level of conviction with his trades
Once Bass has established a thesis on a particular trade, he has complete confidence in it. It no longer matters what other people think. For example, before the housing market collapsed there were plenty of market professionals that told him he was crazy. Despite this he stuck with his original thesis. Had he listened to the naysayers he would’ve not only missed out
on making a fortune but he may very well have lost money when the market inevitably shed 40% in 2008.
This level of conviction is a product of thorough due diligence. In 2007, as part of his research, he hired a team of private investigators to investigate the ease of obtaining a mortgage.
3.) He’s a master of structuring his trades
Bass focuses on sizing his positions appropriately and closely considers the risk and reward of each trade. Once he’s set his thesis he analyzes all of the various financial instruments and assigns probabilities to them to identify which asset class will yield the most favorable risk/reward ratio. For example, after he noticed a red flag in subprime mortgages he then chose to use credit default swaps to position himself. In doing so, he was able to maximize his profit compared to if he has simply shorted U.S. equities.
4.) “The past doesn’t necessarily tell you how the future will play out”
He suggests that a lot of traders get themselves into trouble by trusting correlations too much and thinking that the future will play out just like the past. He describes how it’s almost a “pavlovian” tendency for traders to spot a relationship between two assets and interpret the correlation as causation. As an example he uses the relationship between Japanese equities and the Yen to explain how the correlation between the two could breakdown at any time.
5.) His Fund’s strategy is a hybrid between Global Macro and Event Driven
In the hedge fund industry it’s common practice for funds and managers to stick to one specific approach to investing. Not wanting to “back himself into a corner” or limit his funds objectives Bass chose not to distinguish between a global macro approach and an event driven approach. He calls his funds strategy “global event driven.” His legendary bet against the housing market in 2008 is a perfect embodiment of this idea. His investment thesis on that trade essentially looked to exploit the shifting macro economic climate triggered by a specific event, the collapse of the housing market.