I viewed Kyle Bass’ presentation at the Strategic Investment Conference 2013 on his Japan thesis (link here). He has quite a number of similar posts on Japan on his blog, and has publicly shared his views since 2012.
Part of his thesis has played out very nicely as the Yen topped out in October 2011 and went down significantly in 2012 and 2013.
One takeaway for me is his regular use of derivative instruments to make convex macro bets (i.e. superb risk-reward bets). It’s like taking multiple directional bets using options which supercharge his returns, especially when his analysis is solid (hence accurate), and when he sees things happening before anyone else so that the Street did not price in the significant tail risk when they sold him the derivative instruments.
This is a very very interesting strategy. When you have bets that pay off hundreds of times your investment, you only need very few of these bets over long periods of time to make ship-loads of money, especially because such macro events take time to play out. For Kyle Bass, he caught the mortgage subprime crisis, the Europe debt crises, and now he’s playing the Japan crisis.
- JGB Sellers
- GPIF (Government Pension Investment Fund) needs to sell JGBs to raise cash for pension payouts because of Japan’s significant aging population.
- Institutions will also sell JGBs. Abe’s aim to make CPI go to 2% means that the JGBs will have negative real rates of return.
- JGB Buyers
- The Bank of Japan is buying with their QE, but the plan is not big enough to absorb the selling.
- That’s why they are aggressively asking the Japanese public to buy (even marketing using AKB48)
- Japan is insolvent
- Japan will lose control of their rates and currency in the next 2-3 years.
- Current account surplus is almost gone. Budget deficit is ~11% of GDP.
- Debt is more than 20x its tax revenues, Japan is already insolvent.
- They plan to essentially double their monetary base in 2 years. They will materially devalue their currency (target of 118-120 by end-2014), make themselves slightly more trade competitive, and try to hold interest rates down.
- Smart institutional investors in Japan are already selling their Yen to purchase assets in other countries.
- Japanese equities may not be a good bet even though Yen is going down
- Need to look at who the Japanese are losing their trade competitiveness to (e.g. the Koreans). It is not as simple as Yen goes down, Japanese equities go up.
- Investment Banks were not properly pricing the risks in their products
- Quote: “The AIG of the world is back – I have 27 year old kids selling me one-year jump risk on Japan for less than 1bp – $5bn at a time… You know why? Because it’s outside of a 95% VaR, its less than one-year to maturity, so guess what the regulatory capital hit is for the bank… I’ll give you a clue – it rhymes with HERO… If the bell tolls at the end of the year, the 27-year-old kid gets a bonus… and if he blows the bank to smithereens, ugh, he got a paycheck all year… We are right back there! The brevity of financial memory is about two years…. I wouldn’t sell nuclear holocaust risk in Dallas for 1bp – you should be fired for thinking about selling something for less than 50bps.. and yet – this is happening again…”
- Get out of Yen
- Get out of JGBs
- Be wary of buying Japanese equities.
- Go for convex bets to buy cheap optionality.
- Kyle Bass bought half a trillion dollars worth of these options.
- From a blog post on March 22, 2012, Hayman Capital betted on Japan problems using CDS, swaptions, puts on Yen as well as options on JGB. The risk/return is between 1/15 – 1/100, with a target of 120 USDJPY.
- He had previously used 20% of his AUM to buy CDS on the European countries (Greece, Portugal, etc.) which made him 700x on his investment.