Armed with a PhD in plasma physics, Scott Peng was doing next generation research on rockets for NASA before joining First Boston. He soon became engaged in the derivatives market, spending time as well at Lehman Brothers creating structured notes. We first consider some of the notable debacles in this product set, like Procter and Gamble and Orange county, outcomes that Scott sees as the result of shortfalls that end users had in understanding the risks they were ultimately taking on. Seeking to close this gap, Scott wrote “The Structured Note Market”, a deep dive into the financial engineering that underpinned the creation of these products.

Scott Peng, PhD, Founder and CEO/CIO, Advocate Capital Management

The Alpha Exchange is a podcast series launched by Dean Curnutt to explore topics in financial markets, risk management and capital allocation in the alternatives industry. Our in depth discussions with highly established industry professionals seek to uncover the nuanced and complex interactions between economic, monetary, financial, regulatory and geopolitical sources of risk. We aim to learn from the perspective our guests can bring with respect to the history of financial and business cycles, promoting a better understanding among listeners as to how prior periods provide important context to present day dynamics. The “price of risk” is an important topic. Here we engage experts in their assessment of risk premium levels in the context of uncertainty. Is the level of compensation attractive? Because Central Banks have played so important a role in markets post crisis, our discussions sometimes aim to better understand the evolution of monetary policy and the degree to which the real and financial economy will be impacted. An especially important area of focus is on derivative products and how they interact with risk taking and carry dynamics. Our conversations seek to enlighten listeners, for example, as to the factors that promoted the February melt-down of the VIX complex. We do NOT ask our guests for their political opinions. We seek a better understanding of the market impact of regulatory change, election outcomes and events of geopolitical consequence. Our discussions cover markets from a macro perspective with an assessment of risk and opportunity across asset classes. Within equity markets, we may explore the relative attractiveness of sectors but will NOT discuss single stocks.

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It was a pleasure to welcome Kris Kumar, CIO of Goose Hollow Capital, to the Alpha Exchange. Our conversation starts with Fed policy and the manner in which the 500bps of policy tightening is impacting the economy. To this, Kris argues that the propitious starting position for households and corporates in this cycle has been quite different than in previous ones, thus blunting the impact of rate hikes. He points as well to loose fiscal policy with the unemployment rate so low. For Kris, what happens next depends more on fiscal than monetary side.

We next consider the backdrop for valuations, starting with fixed income. Kris sees safety that comes from a coupon on 2’s that approaches 5%, noting that there are positive real yields generally in most of the world.  From an earnings yield perspective, however, US equities have zero premium to bond yields and Kris points to the concentration of earnings growth coming from the top of the SPX, which, in turn, is a bet on generative AI.  Should this growth not materialize, the lofty multiples currently awarded these stocks could be re-rated.

Within equities, Kris makes the argument that we’ve invested a lot in bits but not in atoms and, going forward, investment dollars may move away from tech into areas associated with energy demand. How else to satisfy all of the incremental power to run all of the data centers built? 

We finish the discussion with an assessment of the price of vol. Kris points to the epically low implied correlation on the SPX, a result of the bifurcated market in which a small but valuable subset of the index is a bet on AI. He sees scope for the still elevated level of rate vol to come down but upside in vol on commodities like copper as a function of all the spending on infrastructure that will ultimately come as a function of the AI boom.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Kris Kumar.

Kris Kumar, CIO, Goose Hollow Capital

The “rule of 72” tells us that a good approximation for the time it takes to double your money can be arrived at by taking 72 and dividing by the interest rate that capital can compound by on an annual basis. Implicit in the calculation is that the initial stack is left untouched and is not vulnerable to a drawdown. In this context, it was great to welcome Jerry Peters, the Managing Partner of Smithbrook to the Alpha Exchange. Providing a risk-managed equity solution to its high net worth clients, Jerry and team are focused on managing downside risk, utilizing an option overlay strategy to mitigate some of the invevitable swoons in equity prices.
 
Our conversation walks through how index put options – when acquired at the right price – can create gains that help offset portfolio losses during times of stress. Acknowledging that the long term expected value of buying insurance ought to be negative, Jerry walks through how a protective strategy can interact with long risk exposure to create long term return enhancement. Here, he points to how gains from insurance during sell-offs can underpin the “rebalancing bonus”, where capital is moved from winning to losing assets on a systematic basis. We also talk about some of the subtle aspects of financial asset taxation and efforts to maximize not just the pre-tax but also the after-tax return of investment decisions. Jerry walks through some straightforward tax loss harvesting strategies that can add meaningfully to investment outcomes on an after-tax basis.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Jerry Peters.

Jerry Peters, Managing Partner, Smithbrook, LLC

After a 13-year career at CSFB where she would ultimately head the firm’s equity derivative strategy effort, in 2023 Mandy Xu moved to the CBOE where she’s now Head of Derivatives Market Intelligence and swimming in interesting, complex data sets. Our conversation surveys product innovation, going back to the first option trade ever on the CBOE, call options on July 1973 Xerox, through today’s vastly electronified ecosystem of trading in cross-asset risk exposures.

We briefly review the unbelievable short squeeze in GME from 2021, and here Mandy asserts that today’s exposures are considerably more balanced than the Meme episode in which the retail stampede engorged on call option premium. Our discussion moves to the present-day backdrop for option pricing and the potential impact of mechanical flows resulting from vol being bought and sold in the market.

Noting the substantial increase in AuM for overwriting and option income generating funds in both the mutual fund and ETF complex, Mandy is skeptical that this growth is solely responsible for the low clearing price of measures like the VIX and put skew. Instead, she points to low risk readings in other asset classes, including credit implied vol, as more likely driven by stable macro fundamentals.

We spend the remainder of the conversation on the much debated topic of ODTE and whether there’s an accident waiting to happen. In Mandy’s role at the CBOE, she sees option flow data with great granularity and in the ultra-short-dated category, she sees considerable balance in use cases across hedgers, income generators and intraday traders. The result is a healthy mix of buyers and sellers and, at least for now, a low risk of Volmaggedon 2.0. 

I hope you enjoy this episode of the Alpha Exchange, my conversation with Mandy Xu.

Mandy Xu, Head of Derivatives Market Intelligence, Cboe Global Markets

Kieran Goodwin’s roots go back to the early days of both distressed debt investing and the credit default swap market, two classes of risk he has seen experience significant change over the last 25 years. Our conversation gets underway by exploring the notion of alpha decay in the distressed market, a diminishing opportunity set that has resulted from smarter capital entering the space, equipped with an understanding of the often complicated process around bankruptcy and reorganization. Kieran frames out the option characteristics of distressed investing in an interesting way, suggesting that the short or long profile of the exposure is about whether time is on your side or not while also arguing that it is arming yourself with a margin of safety in price that creates this runway, leaving the trade with more long vol attributes.

Distressed investing today, in Kieran’s view, is an adult swim only business, rife with creditor-on-creditor violence and requiring a large balance sheet to be in the room as indentures are changed or portions of a capital structure are being primed. We spend the remaining part of the discussion on the CLO business and the potential for a credit-widening cycle. Kieran describes the CLO machinery as a captive buyer base for loans that has served effectively as a quasi-index product that has facilitated market growth. While noting that the product has indeed been effective over the years, he points to concentration risk that can lead to a rapid rise in correlations and spreads. He also points to at least some early signs of an uptick in defaults.

Lastly, we touch on the electronification of credit trading and the factorization of credit exposure that technology has increasingly enabled. Involved as an investor in some of the initiatives to facilitate electronic trading, Kieran sees further growth here, accompanied by more continuous trading and price discovery.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Kieran Goodwin.

Kieran Goodwin, Consultant, Saba Capital Management

In Lori Calvasina's role as Head of US Equity Strategy at RBC Capital Markets, assessing the interaction between macro variables like rates with top-down factors like the equity market multiple is critical. But important as well is an evaluation of markets from the bottoms up. And here, she not only seeks to pull together the views of colleagues doing strategy work in sector verticals, but also to actually read earning transcripts during reporting season to get a sense of what companies are saying. Her broad assessment of the outlook for corporate America is generally optimistic as she sees companies having come out of multiple stress exercises - trade wars, the Covid shock, and the inflation and monetary policy response in the Pandemic's aftermath among them - with a stronger defensive plan. Companies are harnessing technology and managing costs more effectively, leaving them less likely to be forced to reduce headcount. The result is a consumer holding up quite well.

Our discussion touches on the Mag7 and how today's top-heavy portion of the market is similar and different to the highfliers of the tech bubble. For Lori, the valuation premium for names like NVDA and other mega cap tech stocks is justified by the premium of earnings growth they've been able to consistently deliver. We explore the impact of higher rates on the market's multiple and the relative performance of sectors as rates rise or fall. She likes energy, both for its high dividend yield, its strong relative performance as rates rise and the potential for a geopolitical tailwind. On this last front, asked about the market risks that she worries about, it is uncertainty on the global political front along with the US election. She also cites sentiment that may be too bullish and positioning that appears stretched. Lastly, we touch on Lori's recent recognition as one of Barron's Top 100 Most Influential Women in US Finance. Asked about industry efforts to empower female careers in finance, she's optimistic, arguing that it's critical to have not just a mentor but a sponsor as well to push you to the next level.

I hope you enjoy this episode of the Alpha Exchange, my conversation with Lori Calvasina.

Scott Peng, PhD, Founder and CEO/CIO, Advocate Capital Management

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