How did you wind up as a trader?
I was looking around, and this work seemed very interesting because the structure of the world financial markets was changing, which meant opportunities would arise. So I started trading for my own account.
What changes have you seen?
First, the collapse of the Bretton Woods agreement, which freed up currencies to move. Second, ending the prohibition on gold sales. But probably the single most important factor was the development of the futures markets in currencies and interest rates. I remember one of my first trades involved calculating implicit yields in Ginnie Mae spreads. I was just an unemployed ex-professor doing fairly rudimentary work. But a number of us felt these were going to be very important new markets.
Were many hedge funds doing this?
Not many. The term “hedge fund” didn’t start being used until the late ’80s or early ’90s. I was a commodities trader for a very long time, even though it was not literally what I did most. I was registered as a CTA, a commodities trading advisor, and I remember the totally blank looks I would get on the faces of people when I would explain what I did. I’d explain it for five minutes and you could see them drifting off. And then they’d say, “So you’re like a stockbroker, right?” And I’d say, “Yeah, sure, like a stockbroker.”
Did you ever work in the futures pits?
For a short period of time, I went down to the floor of Comex. I got a seat on all the exchanges — I had a wonderful little gold badge that let me trade on all of the New York commodities exchanges. I wanted to understand what happened on the floor. I thought it was an essential factor in understanding the behavior of markets — the daily behavior, the way risk works and how stops were placed. I was totally unsuited for it. I wasn’t aggressive enough to push my way into the front of the pit. You know, it’s a bit like being under the hoop in basketball. You don’t get to stay there very long. People push you out. It’s quite a physical thing.
Did you get the understanding you sought?
In all things you get only partial understanding. But did I get some? Sure. And it was fun. I think part of it was just the pleasure of exploring a new world. But my skill set had more to do with analytics — what we call upstairs trading.
What market lessons have you learned over the years?
Some markets have very long, quiet periods. Some markets and some instruments become obsolete. Some markets become arbitraged out. The excess return in them goes away. One of the most important skills you need is to constantly reinvent where you put resources. Commodities markets were quiet for years. Now they’re very strong.
Does this mean that you must constantly make a macro judgment?
The view I started with and embodied in Caxton’s fund was that business cycles were very important and that they occurred all over the world, and it was useful to observe them and to take advantage of the opportunities across four different asset classes.
Which four asset classes?
Equities, fixed income, commodities and currencies. The raison d’être of the company is to observe the nature of the macro cycle across multiple economic and political zones and to take advantage of the character of each business cycle so that we would have multiple business cycles to trade. We trade Asia differently than we trade Europe or the U.S. And we could be long or short across multiple asset classes and regions. Until the late ’90s, this was not widely done.
Does the tremendous amount of money in hedge funds now make it more difficult than ever to exploit inefficiencies?
Yes. The crowded nature of the hedge fund community has changed the character of trading so that you can see waves of risk-taking and derisking coming from the hedge funds themselves. When there were ten or 15 very active hedge funds, it didn’t matter what they did. When there are 10,000 hedge funds, it does matter. They move the markets. In addition, market opportunities get arbitraged out somewhat. Fifteen years ago, I might have traded some things that we don’t trade at all now.
Like what?
I don’t try to outguess the employment statistics on the first Friday of every month, because everyone is watching the numbers coming out. So now you must seek out undiscovered information somewhere else.
Outside the U.S.?
We’ve always looked outside the U.S., but in the past decade non-U.S. markets have become so much more liquid. There are many more opportunities in emerging markets. But we also find plenty of opportunities in U.S. and developed markets. U.S. markets are still more liquid than almost any other market, and that opens up opportunities.
What role have hedge funds played in the rapid run-up in oil prices?
Hedge fund participation in the oil price rise has been somewhat smaller than I would have expected. The price of oil is elevated for reasons that have much more to do with fundamental demand out of China and India and other places. The weak dollar has added to it.
Are hedge funds beaten up on too much?
I think so. Hedge funds are part of the demonization of financial markets. I think it’s a tradition in American politics to blame the banking community. This tendency goes all the way back to the famous William Jennings Bryan speech that ended “you shall not crucify mankind upon a cross of gold.” This was essentially an anti-inflation policy that was thought to benefit bankers against the interest of the average man — the gold standard policy. And now in the present period of extreme tension on financial matters, it’s hardly a surprise that people blame the participants in the financial markets. Hedge fund managers often get blamed because their profits are seen to be large. It’s easy to confuse public policy problems such as a collapse in the credit markets with ad hominem complaints about hedge fund managers who have made correct market bets. But in reality, the hedge fund manager didn’t cause the problem.
Politicians are looking closely at the taxes that hedge fund managers pay — or don’t pay.
I think it’s an absolutely legitimate public policy question: What’s the right tax policy? It’s a good thing to have a public debate on that. No single policy will make everyone happy. I can’t say I like writing large checks to the IRS, but I am very happy that good trading has put me in a position to do that. The best policy would probably be to have an extremely simple tax rate for all income. But our tax code is tens of thousands of pages long, and it creates a lot of problems.
— Interview by Stephen Taub
