Einhorn's Macro Trades

We know that Einhorn has taken a view on some sovereign credit, Japanese yen and gold etc.  So I thought I'd take a quick look at his macro positions.

First of all, for reference, at the end of the first quarter total investments were $1.18 billion and shareholders' equity was $869 million.

Positions
This is not all of the macro positions, but just some of the larger ones:

Long Position:
   Commodities:  $104 million

Einhorn has said that he wants to keep 10% of funds invested in gold as a tail hedge, so I guess this $104 million is all gold.  He also owns gold stocks which would be in the equity portfolio and may own some GLD which may be booked in the equity portfolio.

Short Position: 
   Non-U.S. sovereign:  $150 million

Interest rate options:  $3 billion notional amount

Credit default swaps:
   Sovereign debt:  $281 million notional
   Corporate debt:  $287 million notional

Put Options:  $260 million notional amount (Japanese yen?)

Futures:         $335 million  (doesn't say if it's long or short or what the underlying is; probably interest rate instrument given interest rate exposure table below)

For the above positions, I would guess that the sovereign shorts and interest rate options relate to the Japan trade and may include others.

Foreign Currency Risk
GLRE has exposure to foreign exchange, but the big exposure is the Japanese yen (JPY).  In the table in the 10Q that shows FX risk, it shows that a 10% increase in the U.S. dollar against the JPY would lead to a $40 million gain, and a 10% decrease would lead to a $15 million loss.  The asymmetry is due to the position being held as a put option.

So this is a pretty large position.  There is a smaller position in the Euro, but it seems the JPY is the big FX trade.

Interest Rate Risk
The interest rate risk table shows what the exposure is on a 100 basis point move in interest rates due to holdings in corporate bonds, sovereign bonds, interest rate options and futures, credit default swaps etc.

Below is the gain on a 100 basis point increase in interest rates (this isn't the whole table; I just picked large items, and it's pretty symmetrical so I didn't put in what happens on a 100 basis point decrease in rates).

Debt:                            $11 million
Interest rate options:     $1.5 million
Futures:                        $15 million
Net:                              $27 million


So that's a snapshot of exposures that GLRE has on the non-equity portfolio;  a sizable position in gold, Japanese yen puts, short sovereigns and interest rate futures and long some credit default swaps on corporates and sovereigns.


How Have These Trades Done in the Past?
GLRE breaks out gains and losses recognized in their derivatives portfolio so I looked at the past five years (they didn't disclose details further back) to see if they have been making money on these trades or not.

Here are some figures I pulled out of past 10K's:

             gain (loss) on derivs:                Total gains recognized in income
             Equity:                                      Shareholders' equity of GLRE
             Total Inv:                                  Total investments of GLRE
             Gain/loss on equity swaps:       Derivs gain/loss on equity total return swaps
             % equity:                                   derivatives gain/loss as a percent of shareholders' equity
             % invest:                                   derivatives gain/loss as a percent of total investments
             derivs gain excl equity swaps:  Total derivs gain/loss without equity swaps
             % equity:                                    the above as a percentage of shareholders' equity
             % invest:                                    the avove as a percentage of total investments
             Investment return:                     Return on investment portfolio at GLRE

So it looks like these derivatives positions have cost GLRE some money over the years.  Equity total return swaps are included in here, but these may be part of the equity portfolio so it may not be a good idea to include.  They may be structured to offset positions in the equity book etc.   It doesn't reflect, I don't think, Einhorn's macro views.  That's why I created a column where I net out the equity swap gains and losses to get a more 'pure' derivatives gain or loss.

According to that, GLRE has usually spent around 1.6% per year of the investment portfolio on these macro trades.  Of course, the temptation is to think that if Einhorn didn't do these trades, then GLRE would have done 1.6%/year better in their investment portfolio.

But I would not look at it like that.  If these macro, tail hedges were not on, then Einhorn very well may have had less long equities or otherwise reduce risk (and return) elsewhere in the portfolio.  So you can't really look at it that way.   (You would be slightly better off without homeowner's insurance too, but would you really live in a house you own if it wasn't insured?)

Also, this derivatives gain/loss doesn't include their large gold position which is held as a commodity long position, not a derivatives position  (Also, gold stocks and gold ETF's would be in the equity portfolio). 

So just looking at the derivatives gain and loss like this doesn't tell the whole picture.
Judging from the above table,  I am sort of surprised that there wasn't some sort of gain during the financial crisis in 2008-2009.  But overall, it seems like a manageable expense to keep these trades on as they may eventually work out.  Even if not, the overall investment performance with these derivatives losses has been pretty good in an awful environment.

Anyway, it looks like they have some sizeable positions that can really benefit from some chaos in the market.  A $3 billion notional amount interest rate position is large; almost 3x the total investment portfolio.  But since this is in the form of interest rate options, the downside risk is limited so this won't lead to any unpleasant surprises.

The JPY position, too, is a put option so can't cause big damage.  The worst that can happen is the option expires worthless.

Additive to Returns
What's important to remember is that these positions are additive to total returns and don't require a whole lot of capital.  A lot of these positions can simply be supported by the assets held in the investment portfolio. 

Despite these large 'bets', GLRE maitains a fully invested long/short equity portfolio at the same time.  As the above shows, even when the trades don't work out, they don't lead to large losses, but small losses sort of like the cost of insurance.  Einhorn is managing this part of the portfolio, presumably, like an insurance plan (small constant losses are OK to protect the portfolio and for a chance at outsized gains when he is right).

The other thing to remember is that these macro trades cost very little for GLRE and he gives up nothing on the long - short equity side. 

Time and again, I hear of and talk to people who try to trade in and out of leveraged interest rate and FX ETF's to try to make money (and nobody does, of course).  But these folks usually have to sell their Apple stock to buy their 3x leverage interest rate ETF.  Or maybe they sell their MCD stock or whatever.

Institutional Advantage Over Retail Investors
So for most individual investors, these macro plays turn into either-or situations; either they maintain a stock portfolio and stay away from the macro stuff, or they sell some of their stocks to put on some macro plays via various ETFs.

What they don't realize is that guys like Einhorn don't have to do that at all.  They can still stay fully invested in their best stock ideas, and oh, if they see a good macro trade, they can put on sizable interest rate and foreign exchange positions.

This, by the way, is why people like Soros was able to make so much money over the years.  In all those years he made huge amounts of money on macro bets, he typically had an equity portfolio supporting all of that, and in bull markets it funded many of the macro bets (or subsidized them in dry periods).

Individual investors typically don't have that advantage, so if they don't like the market, sell their stock and buy inverse bond ETFs, they are screwed when they are wrong.  They might get a double whammy; they lose money on the ETF trade, and most likely the stock they sold went up!  (this scenario is most likely because it's often at bear market bottoms where individuals decide to sell their stocks and buy an inverse S&P fund; they sell their stock and go short at precisely the wrong moment!)

Not Einhorn.  If he is wrong, he still has his equity porfolio and he can manage his macro exposure without touching it.

That's a big difference and is really the key to why some of these hedge funds can make such great returns over long periods while individual investors that try to become a George Soros often fail; it's almost impossible to pull off without this advantage.