Hugh Hendry On “The Arrogance And Conceit Of A Well-Formed Argument”

    In his latest interview with RealVision’s Grant Williams, former Eclectica asset management co-founder Hugh Hendry delineates what he calls the “arrogance and conceit of a well-formed argument,” using examples from his own career, which has recently taken a difficult turn.

    In September, Hendry shuttered Eclectica after 15 years, angrily declaring that “markets are wrong” after a badly timed long-vol bet resulting in some of the worst monthly P&Ls of his career back in July and August…

     

    Hendry

    At the time, the 9.8% YTD loss triggered massive redemptions, which left the fund – which as recently as a few years ago managed billions – with just $ 30.6 million as of Aug. 31. At the time, an exasperated Hendry declared it wasn’t supposed to be like this…

    Eclectica’s final P&L:

     

    PL

    But a few months distance has clearly helped rejuvenate Hendry. In the interview, he shared some of the lessons he learned from one of the biggest defeats of his career:

    He started by recounting a bet on Readers’ Digest magazine, an iconic American brand, Hendry said. He described his thought process at the time thusly: Because of its stature and its utility to working-class people, Hendry said he “bought in to the story” that the magazine would endure…but he was wrong…

    “…So Reader’s Digest, you know here’s something where it’d been around forever. Dee Witt and Lionel Wallace had set this up were unbelievably rich, and you were just taking newspaper clippings, putting it together, and there are all these stories about after the Berlin wall came down. For so many people were trapped on the wrong side of the wall, except with communism, Reader’s Digest was like Coca-Cola; if only. I really bought into the story that Reader’s Digest was this iconic everything about America…”

    Hendry ended up booking a 50% loss. Later on, the magazine went out of business, prompting Hendry to engage in some valuable introspection…

    ….Ultimately, Hendry learned to question reductive narratives, instead of letting them guide his investment decisions…

    “…What is it like to lose 50% in a position, that’s the one you go back over again and again and that Reader’s Digest was one that I kept going back over again. What did you learn from it? I learned that the… how you become hostage to the clever, you can be hostage to the clever narrative, that the narrative has to have the legitimacy of a downtrend. That things don’t happen just because you’ve come across some wizzy theory, and back to that notion of inventory management, by all means come up with these ideas. You know, monitor them. But it’s the diligence and the wisdom to apply them only when they become relevant. I mean, that thing, it went bankrupt…”

    Circling back to the circumstances that precipitated Eclectica’s collapse, Wynn explains that his doomed long-vol trade was the result of putting his faith in an incredibly complex strategy that many of his investors were unfamiliar with.

    The experience, Hendry said, reminded him from a famous scene from the movie “Margin Call” (in our opinion, one of the greatest Wall Street movies ever made).

    In the scene, actor Jeremy Irons – who plays the CEO of a Lehman Brothers-like investment bank as the first stirrings of the financial crisis began to unfold – advises one of his analysts, who was the first to discover the preciousness of the nearly worthless mortgage-backed assets on the bank’s balance sheet – to explain the problem to him “as if he were a young child, or a golden retriever” adding “it wasn’t brains that got me here, I can assure you of that.”

    The trade was a bet that a sudden surge in equity prices could push volatility higher. Of course, Hendry got crushed as volatility slumped over the summer – eventually touching record lows during the early fall.

    And we were looking for like a very rough 2000 point move and the vol ramifications, yeah I spent, it was very hard to try and explain the intricacies of what we were doing so it definitely failed the complexity… it was a complex trade, and that was ultimately it’s failing, on top of that we ended up being long volatility, long stock volatility, equity stock volatility in a world where quantitative easing, where love it or otherwise, vol comes down. But there was a joy, and that’s what I miss, its that but what if we’re right? What if Santa comes? What’s gonna be under the tree? It’s the intellectual challenge of putting this puzzle
    Together.

    But in an irony that we imagine isn’t lost on Hendry, his thesis proved correct – he was just six months too early – as we explained in a post entitled “This Is What Market Madness Looks Like”.

    Vol has risen along with stocks in 2018…

    Vol

    Driven by a euphoric-buying of levered long stock positions…

    The urge to swing for the fences – the 50% return, as Hendry puts it – is a powerful one, and it drives traders and analysts to scour trade ideas until they find one that warrants absolute conviction…

    “I think we were discussing the… what’s it like, making 50% or whatever, or what’s it like managing money, the great thing, the thing I remember most clearly was, it was like a child on Christmas Eve, like when you create some of these convex trades and you think “what if we’re right? Just… what if we’re right? You’re not the, oh my god we’re going to make 10 million dollars…”

    And that’s the game, really. Opening these incredibly convex positions is incredibly gratifying…until it’s not.

    And that, really, is the lesson here…

     

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