When Opportunities and Timing Perfectly Align w/ Osman Ozsan

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1:24And now to the top analysis of today's markets.

1:31Welcome to the next big trade and thanks for joining us. This week I'm talking to Osman Osan. Osman founded Deuterium Capital Management in 2018 and manages the Deuterium Absolute Return Fund in addition to his role on the GDA team. Osman also manages private investment portfolios and a private equity pool for clients of the firm. He studied law at the University of Bristol before moving to graduate study at the Stern School of Business. Oz has led an extensively international career working in investment banking at Barclays and UBS and trading interest rate and currency derivatives and debt insurance.

2:10You know, your career sounds a lot like mine in some respects. How did that happen? I think we've met before, and thanks for having me on your podcast. We may have met before, but it's nice to talk to a fellow North Londoner. So we should admit it that you are a bit North London, aren't you, Oz? I think, yeah, there's no hiding that and there's no attempt to hide it either. That's what I like to hear, isn't it? So, and we have, yeah, for full disclosure, Oz and I have worked together in London at UBS, although he was in London and I was in New York, and in Moscow, where we have stories. What can I say?

2:50Which we sometimes try to forget about. We do. We do. So I'm told these days, Oz, that the greeting in North London nowadays is wagwan. I see. What did you used to say growing up? Is it watch your... All right, mate. Yeah. All right, yeah. Yeah. You kind of put me on the spot there now. It's like my age is going to start telling. I've got a mate over at the debt management office in the UK, a guy who used to be an interest rate strategist for Morgan Stanley. Okay. And every time I call him up, he says, whatcha? I haven't said that in a long time. I forgot that existed. That's a good one. That's a good greeting.

3:39So tell us a little bit about you and about Deuterium. Go on. We know you're a North Londoner, but tell me about Deuterium. Well, as you've mentioned, my background was mostly in trading interest rate and currency derivatives over the course of my career. The few other bits and pieces here and there. But essentially, the idea for Deuterium originally was to look at ways in which that you can bring that experience as an external CIO to large family offices. What I found, though, very quickly is that there was a lot of interest for that, but the amount of discretionary money that kept flowing in just got to the point where it made the most sense to start a fund.

4:20And so from there, overnight, we were in the fund management business. And that was a much more natural way to deploy assets that we were given to manage, advisory that we were asked to do. And so we've grown pretty dramatically in that time. I think we were around the 1.2 billion mark in terms of assets under management. We managed four funds with two broad strategies. So we've got the, you mentioned the GDA, the Global Dynamic Allocation Fund, that's headed up by my business partner, John Ricciardi. And I run the absolute return strategy. And there's a little bit of nuance between how those two things work.

4:59But essentially, they are macro in nature, right? So, for instance, we have a data science team who crunched through hundreds of thousands of data series. We build models from there. We build forecasts on, like, what's GDP going to do? What's industrial production going to do? That's a huge input to our overall process of trying to understand the broader world around us. The dynamic allocation fund essentially follows a model portfolio generated from there with a strong sort of manager overlay. It kind of takes that strategy from being a quartile in the top quartile fund to being a top decile fund.

5:38In the absolute return fund, while we do do a lot of that work, we essentially are four PMs in there with four pretty much orthogonal approaches to how we kind of build out our trading strategy. But it's much more like what you and I would be akin to as a prop portfolio than it is a, hey, here's everything that the MSCI world says I should own. What bits do I trim? What bits do I not take on board? How do I meet my ESG responsibilities and all of that? Like, in the absolute return fund, we care about that in a very different way. We have much more highly concentrated positions. And essentially, the real kind of crux of it is like, we're looking at things we can monetize on a three-month to 18-month basis.

6:26So we're not like so much involved in the day-to-day. UNS did this and the S &P did that as a sort of trading style. I think that especially given how much high frequency traders there are out there and whatever, I don't see a huge amount of ways of really adding a lot of value beyond sort of what one of our managers does, which is to sort of take a very quantitative approach to trading some of that. So the bulk of the money is kind of employed on that time horizon, we try to look at ways of like, say, AI is a very topical thing at the moment, right? We've been in the AI trade for quite some time, but obviously you're not putting on bets that you think like, you know, that our grandchildren would favor from.

7:14So, you know, the plays were very clear, you know, of the, someone pointed out to me in the office the other day, of the six stocks that have performed most strongly in the last six months, we've owned four of them. And we've had them for quite a while. You go back on our 13Fs, we've had them for quite a while. And they kind of checked a lot of boxes because you got to play AI, you got to play the crypto from the picks and shovels perspective, the growth picture, innovation, all of those things we try and get exposure to in the absolute return fund. It's all worked very nicely. And it's kind of at the point where we're actually harvesting out those trades.

7:53But that's kind of the broad approach. So, you know, good macro solid understanding from the bottom up. And then we look at ways in which to really kind of put interesting trades on around things that we think we should get exposure to. Okay. So that I think naturally segs into the whole point of this podcast, which is, you know, the next big trade. And my understanding is your next big trade is there is no next big trade. So talk to me about that. Yeah, it's kind of like that. I mean, as I touched on, right, like the AI theme, I think, you know, is definitely something that everyone needs to think about in terms of like how it sits on their portfolio.

8:36We've had such an amazing run. If anything, we've been sort of exiting a lot of those positions that we've had or scaling back on them. How did you express the AI trade? What was the expression of that for you? The simplest one was you own NVIDIA. Right. You own the market leaders. You own who are the leaders in cloud or who are underpriced. Oracle is a good stock that we've had decent exposure to. Microsoft is another bit of Apple, not huge. But NVIDIA was kind of like the real key thing. Other stocks that we've held that we strongly believe in that have other potential, but doesn't necessarily play the AI theme of stuff like ISRG and so on.

9:27A lot has been said. I think when you start getting Nvidia trading at hundreds of times earnings, you might want to take a little bit off. We've definitely been doing that. But I think that we're kind of at certain levels where we're pricing so much, we're grabbing so much from the forward curve in terms of what's projected for earnings that I feel less comfortable holding it as a big dominant position on the portfolio than I did six months ago. Hey, everyone. We're going to take a quick break right now to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision Daily Briefing.

10:08ah so this i'm intrigued by this notion that the next big trade is that there is no big trade for one it reminds me of that scene in the matrix where that bald kid wearing the toga says something to neo he says do not try and bend the spoon um it is impossible instead only try and realize the truth there is no spoon well okay you know why is there no spoon i don't you know what give me some macro that explains why you too much in the price of AI fine but why why is there nothing out there you want to bet your bulls on right now I think you want to take a balanced approach right now like you know when we look at say our macro models everything looks fine you know it's been a miracle to have this much in rate hikes at such high speed very reminiscent of like sort of 2005 2006 in some regards, in terms of how great the economy was doing and how robust it was.

11:08Now, you're near the peak in rates. The economy seems to be in good shape. And most of what we're flagging is like, hey, stay long stocks. We've got some signals where you start shifting out of some of the positions like long Japanese stocks into being more overweight US and so on. That's all fine. But I think we have more tail risk today, in a sense similar to 2006 type of era when the Fed was done hiking and so on. We have lots of tail risk. A lot is said about commercial real estate. That's a banking sector problem at the end of the day, particularly in the US where everything is non-recourse.

11:56But what about the huge amount of leverage that's been building up on a corporate level. There are very mixed data points around how imminent is the debt rollover that's been built up both by private equity funds as well as companies who have been avidly borrowing at zero or close to zero rates to buy back their own stock. What happens when you've got to roll that debt? Because even though I think in a sense we're looking at inflation in the rearview mirror now. It's not where it needs to be, which means that rates will stay up here for probably longer than the market keeps insisting on trying to reprice.

12:40And arguably, nothing's really broken yet, and it should be breaking. So I think that's why you want to be cautious. I think that's why even though you're going to be rewarded for holding risk assets over the next six to nine months, you've got to be very, very careful. And I think you've got to be, you probably want to really be careful about how nimble you can be and how quickly you can exit. So in that sense, like, it's more of the same rather than, hey, this is what you should be doing next. But the trade that I do really like, and I think that, you know, because we've got this, we've got the bond market looking at totally different things from what the equity market is looking at.

13:21For the equity market, everything is rosy and fine. Let's just keep pressing ahead. Let's broaden the rally. Rates are much more about, no, no, no, no, it's going to be very bad. There's a recession coming, which we don't see in our models. That's quite interesting. I mean, how is it? I shouldn't interrupt you. You're halfway through making. No, that's okay. But I'm intrigued that your data filtering and mining doesn't see a recession. Can you reconcile that with your own economic views? Why is that happening? What's going on? That's why even though we've got a very systematic approach, the manager overlay piece is important because any type of modeling by definition is simplifying the world around us no matter how sophisticated it may be how extensive it may be it's not going to see some things so you know we as a team across the four funds like spend I don't know four or five hours on on a Tuesday going through all of these things but also looking far and wide at what's being published out there to try and understand the broader risk framework in which we need to operate.

14:39And it's when you look at that aspect of it that we can't model. I can't model what's going to happen to a lot of these companies that sit in PE funds, who have huge amounts of debt. And when they roll them from 65 basis points to 525, how stuff is not going to break. Like, I can't model that. I don't have sufficient information or detailed information to really do a reliable job of saying, yeah, this is what's going to happen. Harry, I'm going to call you around the 17th of September when things blow up. Like, you can't predict it quite that way. So you have to build other things into your portfolio that may create a little bit of drag from what you optimally could make.

15:29But you've got to be very protective of your portfolio. You've got to look at that side of it or you've got to have more convexity than you might be prone to if you just simply. Yeah, you would think this environment would reward you for having a little bit of cheapish convexity if you can find it somewhere on your book. So you made, I think, two quite striking points to me, because they're foremost in my mind, one of which was the Fed is telling us that they're going to keep on going unless we mend our ways. But nobody can mend their ways for various reasons. And the other is the impact of that is going to trickle in over time.

16:12It's not something that happens overnight because nobody refinances overnight. But every month, corporates are refining their debt burden from 3 % to 5 % effective or 7 % effective. Every month, in October, for example, US student loans restart, and people will start paying the debt service on their student loans when it was suspended for COVID. There's a ratcheting titer, a kind of backdated ratcheting titer of Fed policy. still doesn't really explain to me why we haven't seen more of an effect from what is quite an unprecedented tightening in monetary policy. Any thoughts on why we haven't seen that effect?

16:59I buy less into, like, you know, sure, there was a lot of fiscal stimulus. That's probably helped households. There's been some shifts in the way people work. You know, there are there are these missing hours of labor that we have in the U.S. labor market, right? Like people just choosing to work less. Like no one has a real explanation of like, why are people chosen to do that? There's lots of ways of explaining it. There's also, you know, if you look at the percentage of hours that are being worked less, You know, graduates are a great example where you, you know, sit in complete opposition to the idea that that guy who's decided that he doesn't want to work 60 hours a week and wants to work 30 and go hiking on Thursdays or whatever he's doing.

17:51Right. At the same time, has a student low repayment issue. These things don't square up very well. And unfortunately, we will understand the economy better later. So in that sense, if you recall, when the Fed was hiking back in 2005, 2006, I don't want to necessarily point the finger at the chairman of the Fed in any particularly bad way. Oh, I do. I met him when they were doing that. Before he was the chair, I had a meeting when I was at Aberdeen with Mr. Bernanke. and in that meeting at some point I said, you know, do you not worry about the real estate market? And he went, no. What's wrong with the real estate market?

18:40Yeah, well, I mean, for me, I never forget his testimony when he said, like, the whole thing is a very well self-contained system now. Yeah. Because of credit derivatives. And that's a great example of where someone looks at it from a purely financial theory perspective but it's not looking at some of the empirical information about like, well, it's all underwritten by one individual or one entity or whatever. Or, you know, back then, if you asked like, yeah, those people who sit upstairs from us on the credit trading floor who are doing correlation trading, what is that? And it's like, no, no, no, you're a bit too thick to understand how clever they are.

19:24So just carry on with what you're doing. Like it was it was kind of like that was the culture. So you'd ask all these questions or you'd ask you try and understand like you'd read something in the Financial Times or whatever. And you'd be like, oh, yeah, this deal has just gone through and it's been upgraded to AAA because somebody put a wrapper on it and they're charging one and a half basis points per annum running for providing that protection. And they have four pound fifty of capital. They have four pound fifty of capital, but they're charging 100. Are you sure you can really ensure that?

19:55Yeah, just intuitively, the math just doesn't make any sense. But like, you've got a day job to do, and you don't always necessarily get half the time to go and, you know, brush up on all these things and understand, you know, the maths behind copulas and all the rest of it to contest some of this wisdom that's been contained. So, you know, if you think about it, when the Fed started cutting, the real fallout came months later, right? Where like clearly nobody could take the pain anymore. And then suddenly, you know, you had like the June 2007 subprime print, default print or whatever, just spiking.

20:36And then suddenly, like, is this important? And you find out a few weeks later that it's important to somebody. And things like three-month LIBOR over ois is not six basis points eternally it can go higher and then you discover a month later it's not just a month-end issue it's it's a year-end issue and then you suddenly realize no there's something you know and it just keeps unraveling and that's the thing that i think you've got to keep front and center because it's you know history was what's that expression history doesn't repeat itself or somehow it rhymes. There's a little bit of that. What that rhyme looks like, we can speculate.

21:22But I do feel very, very, like on the one hand, like you've got to be long, but I'm very nervous about being long. We're going to take another quick break to hear a word from our partners. We'll be right back with more of the day's top analysis on the Real Vision daily briefing.

21:42So I frame this when I talk about this concept of you need to own assets. I think about it in terms of transmitting consumption into the future. Right. And the asset markets are our only way of doing that. The only communication between the present and future consumption. We rely on other people holding up, you know, maintaining the value of our claims on honouring those claims. If it's US Treasury or Google or whatever, we're relying on those claims being honoured. Well, I suspect that quite a few claims have been issued in the previous 10 years or 12 years since the last big recession that can't be honoured.

22:25And so if you manage to get past what's coming in the next three to five years, you'll have done really well without you know getting buried somewhere um and the question is managing to do that well it's it's a that's a that's a that's a good point i would be interested to know like where do you who do you think are the um the guilty parties in issuing like are they in any particular sector well we know already we already know that there's a problem in cra and And commercial real estate, I don't think it's a university. You'd lump a lot of stuff into that basket. But there's going to be CMBS issued.

23:10One of the things I know is that real estate guys are smart. They're smart. Not all are smart as Sam's El, but they're smart. So when they have a bunch of equity in a deal, they like to take it. They don't like to leave it in the deal to collateralize somebody else's fixed income. They like to take it out and leave you with no recourse. And so on the course of that rally, where we were marking up the value of real estate assets, office, retail, residential, smart real estate punters extracted as much equity as they could. And the people who gave them that exit are pension funds that bought CMBS, some insurance companies that were looking for assets in a yield-starved environment.

23:59and endowments. These guys gave them the exit. So how much of that real estate is an impaired asset? It's a good question. Not all of it for sure, but a lot of it is priced at the wrong price. You know what Harley Basmer says, no bad assets, just bad prices. We've got a lot of bad prices out there. Yeah, we do. We do. I mean, that's why four regional banks blew up, right? The timing could not have been worse in terms of the excess liquidity they suddenly had, the prices available for buying bonds, and how much of it they did. And then suddenly, accrual accounting becomes the friend that killed you.

24:46I'm a much more cynical man about this stuff. I noticed, for example, SVB's principles from Lehman's. And don't tell me that Lehman's bankers don't know that when you go along a lot of fixed income that you've got some duration risk on your book. They knew it perfectly well. What they did decide, what they decided at the time was, I don't think rates are going above 3%. Let's play double of quits here and pay ourselves a 10 million bonus at the end. After all, what could possibly go wrong? and it's not our money anyway right i mean you know it was the most yeah it was to me it was an asinine trade and yes some of it was liquidity and yes they had a halt to maturity book but they you know those deposits they're a block of their depositors some of the sharpest people in the world they smelt what was going on and they legged it nothing surprising at all nothing here that would surprise any North London wide boy.

25:46And what we've now is transmuted that problem from a deposit problem and keeping funds. The Fed has transmuted it into a profitability problem. So we have all these regional banking franchises that can't make any money because they've lost it all. They've lost money for God knows how long. And now they've got depots repricing from zero to five and their franchises don't make money. So there's a lot of little banks in the US compared to the rest of the world. It's going to ration. What do you call it when a sector rationalization? I don't know. Yeah, consolidation. Consolidation. That's the phrase people use.

26:28We're going to have a consolidation in banks and probably a good thing. It's probably the same problem in Europe, right? Or Japan and lots of these places. I'm not an expert on the banking sector, but there are a lot of things that have survived, whether it's because of political motivations or regional motivations or whatever they may be, and you suddenly realise that banking is a really bad left-sku business and we should get out of it. It's a feature, not a bug, right? Sometimes that's great and sometimes it's not a good time to be involved in it. Yeah, that's exactly right. You own the assets that you funded and they're not always great.

27:09Yeah. Yeah. And, you know, when we talk about like this commercial real estate problem, it's effectively a banking problem. Like, yes, sure. Pension funds, you know, may get caught offside by owning these bonds and so on. But, you know, there's just so many there's so many things on a smaller scale where someone just simply goes, I have a non-recourse loan. it's now the problem of XYZ Bank for the county or whatever. Thank you very much. And then suddenly you have this huge deterioration in the overall balance sheet picture and liquidity picture of all these banks in an environment where liquidity is by design getting removed.

27:57That could be a double whammy for stocks, both from a liquidity standpoint. A lot of people have been modeling sort of, you know, where the treasury liquidity stands and how that stimulates the stock market in the short run to just the fact that, you know, certain sectors are just going to fall out of bed and your AI portfolio won't be big enough to compensate you for owning financials, even if you're underweight. Yeah. so just to summarize for people listening in you had these big themes that you liked and they were good to you you had the ai trade and you rode that you like we had a chat before and you told me you like long-term energy resources uh agricultural plays things like that um but the price is not right at the moment and that's why you don't want to play yeah i think so so we have energy is a good one.

28:57So we have some contingent phase there in long dated contracts. We like those trades. They're a bit expensive to hold. There were certain features of the term structure that helped compensate for the high vol and the burn that you get on that and so on. You want to add to them. But these are, I think what I was pointing out to you in the past was like there's lots of technical and structural issues going on there that no one is really focusing on as much as they should. Most people are focusing on the idea that there's going to be a recession and therefore do not own oil or short it, for example.