Making Money, Keeping Money, Enjoying Money with Michael Kao Ep.108
Dec 2, 2023
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Experienced investor Michael Kao shares market wisdom, discussing topics such as inflation, geopolitical risk in the oil market, hedging strategies, COO equity significance, being like a pelican in investing, understanding capital structure and duration, and the importance of conviction in trading.
Being patient and observing opportunities allows you to stay focused on your investment strategy and avoid chasing market trends.
A balanced allocation of investments, including asymmetric hedges and senior secured loan investments, can help protect against downside risk while participating in positive cash flows.
Investing in assets like gold and Bitcoin may carry greater uncertainty and reliance on future value perceptions, whereas investments with clear exit strategies and predictable cash flows are prioritized.
Understanding the continuum of capital structure and identifying fulcrum securities can provide opportunities for significant gains and distribution of value between different securities.
Deep dives
The Pelican Approach: Balancing Risk and Reward
The speaker highlights the importance of being patient and observing opportunities like a pelican. He emphasizes the need to balance risk and reward and avoid fear of missing out (FOMO). The speaker acknowledges that there are always opportunities in the market and that it's okay to let some fish get away, as there will be plenty more. This approach allows the speaker to stay focused on their investment strategy and avoid chasing trades based on market trends.
The Macro Cap Arb Strategy
The speaker discusses their macro capital structure strategy, which focuses on a balanced allocation of investments. They use a combination of asymmetric hedges, such as options, to protect against downside risk, while also investing in senior secured loan investments, like collateralized loan obligations (CLOs). This strategy allows them to participate in positive cash flows from credit investments, while hedging against potential market downturns. The speaker emphasizes the importance of having multiple sources of positive carry and diversifying their portfolio.
The Greater Fool Trades: Gold and Bitcoin
The speaker expresses indifference towards gold and Bitcoin as investment options. They believe that these assets rely too heavily on the greater fool theory, meaning their value is dependent on someone else perceiving more value in the future. The speaker highlights the difficulty in determining entry and exit points for these assets, as their underlying theses are often unfalsifiable. Instead, they focus on investments with clear exit strategies and more predictable cash flows.
Duration Risk and Equity Downside
The speaker discusses the concept of duration risk, considering the varying levels of contractual protections and cash flows within different investment instruments. They caution against taking equity downside risk for fixed income expected returns, highlighting the inherent uncertainty and longer-term nature of equity investments. The speaker believes that many equities are currently overvalued, given the narrowness of the market rally and the lack of current dividend payments in high-growth stocks. They expect equities to re-rate lower in terms of multiples, advocating for a more cautious approach to equity investing.
The Continuum of Capital Structure and Bond Characteristics
The speaker discusses the importance of understanding the continuum of capital structure and the characteristics of different types of bonds. They emphasize the value of buying bonds that have equity upside characteristics and highlight the idea that bonds in distress can have similar risk-return profiles as equities. The speaker explains how buying severely distressed convertible bonds during the financial crisis resulted in significant gains, showcasing the potential opportunities within this space.
The Concept of Fulcrum Security
The podcast explores the concept of fulcrum security within the capital structure. The speaker explains that the fulcrum security is the part of the capital structure that moves most asymmetrically in response to changes in the firm's value. They provide examples of how the fulcrum security can shift depending on the company's assets and liabilities and how this impacts the distribution of value between different securities. The speaker shares a personal experience where they identified and capitalized on a fulcrum security trade during the Great Financial Crisis.
Investing with Conviction and the Dangers of Negative Gamma
The podcast dives into the importance of investing with conviction and the dangers of negative gamma. The speaker highlights that lack of conviction can lead to buying highs and selling lows, resulting in poor trading decisions. They emphasize the significance of having a well-researched thesis and a well-defined exit strategy. The speaker also discusses how negative gamma, or being short optionality, can lead to adverse trading behaviors. They stress the need for discipline and predetermined exit strategies to prevent emotional reactions and impulsive trading.
Market wisdom from one of the best, Michael Kao! We talk about everything from markets and investing to macro and the economy to help you make money, keep your money, enjoy your money. ✨
Michael Kao has been in the investment business for ~30 years with extensive experience analyzing and investing in many markets and asset classes from commodities to credit to convertible/capital structure/event arbitrage to distressed debt/equity investing.
From commodities trader at Goldman Sachs to partner & co-founder of Canyon Arbitrage Fund focusing on various strategies including convertible and capital structure arbitrage as well as event-driven/risk arbitrage and then to beginning his own investment firm – Akanthos Capital Management – where he ran an opportunistic, value-driven investment strategy that looked for “fulcrum securities” up and down the capital structure.
In 2019, Mike stopped actively managing external capital in now invests for his FAMILY OFFICE & became a PELICAN! Mike also shares his wisdom with his passionate creative and insightful projects, Kaoboy Musings substack & Kaos theory podcast.
