RAOUL PAL: Mike, welcome to "Real Vision Live." This is the first time we've done a live event, even though we talked to live many, many times. But I think this should be fun, particularly in this environment. There's a lot going on, and I think people are always interested to hear your perspectives on stuff. First, update people what you're up to now, because you're doing something new and it's very exciting.
MIKE GREEN: Yeah, so when we last sat down in December, I had just left Thiel Macro, which brought me out from behind the compliance firewall and gave me the first opportunity to go out and talk. And as a lot of people have noticed, I've been much more visible since that point. I had begun talking in September of last year, I believe-- it was either August or September of last year-- where you saw me interview Wayne Himmelstein on Real Vision. And for me, that was actually part of the way that I had been using Real Vision up to that point. It was effectively your viewers actually got to see me conduct a due diligence questionnaire-- an interview of a manager that I was evaluating.
In short terms, most people know that I've actually joined Wayne at Logica, taken the position of chief strategist and portfolio manager. Wayne and I now sit on the investment committee. And that interview was actually really powerful for me for two reasons. One, what Wayne was doing in the quantitative space was very similar to what I was doing in the discretionary space. He was very focused in the equity markets. And as people know, I've had views on passive, in particular, and the impact that that has on the equity markets.
But as you also know, I am a discretionary macro manager and so over on FX positions, credit positions all simultaneously. In a lot of ways, those were proving to be a bit of a distraction from my central focus at that point. And so when I decided to leave Thiel and join Logica, we made a very intentional decision to focus on the equity space and to exploit what Wayne was capturing and what I was seeing. We were seeing it through slightly different lenses.
So at Logica, we run separate accounts, and we just actually launched our first fund that are focused on the equity markets exclusively. We trade only listed equities and options. And the focus is very straightforward-- to exploit the mispricing of options that is created by the growth of passive strategies. It's really that simple. And so people tend not to really think about how options are priced or what the assumptions that go into that. And as you know, my favorite phrase is to say either a convexity, which options provide, or to say assumptions and to understand the assumptions that people are making.
At the core of all option pricing models is the idea of the efficient market hypothesis-- that there is no future state that can be effectively forecasted that is not then, in turn, discounted to the present state. That's true if the feature that you're talking about is information-- or can be loosely true if the feature you're talking about is information. But if the feature you're talking about is actually flows, transactions, you can't actually pull that back to the present, right?
And so it creates this very interesting dynamic where a drift has emerged-- and we can actually demonstrate this-- that basically says all options are mispriced. All right, as you have a giant entity like a passive player grow in size and scale and become an increasing fraction of market activity, it creates distortions. And that's what we're exploiting.
RAOUL PAL: And how does that distortion play itself out? Because we've just gone through some extraordinary events now, so you've just been kind of real time living some of this. How does this all play out in more layman's terms for people to understand?
MIKE GREEN: Well, it exhibits itself in a couple of different ways, right? One is most people-- give me one second, I'm sorry. I'm just going to mute for one second while I cancel my automatic vacuum cleaner that just went on.
RAOUL PAL: That's the joy of live events.
MIKE GREEN: OK. Alexa just turned it off for me. So the actual mechanics that you would expect to see there, we wrote about this to a certain extent in the piece that we put out on our website, www.logicoffunds.com, called Policy in a World of Pandemics-- Social Media and Passive Investing. And the dynamics of passive influence the market in two ways. One is there is a giant, systematic player that reinforces momentum.
Most people have focused on this idea in the context of the underperformance of value. And one of the things we do in that piece is we actually demonstrate the value has basically been underperforming since the end of the former French study that said value outperforms. Literally the outperformance of value ended almost the exact month that John Bogle introduced the first index vehicle. Now, I think that's coincidental to a certain extent, but there's definitely an influence component that's going on there. And it's become more powerful over time.
That creates a momentum positive feedback to the top side. And so we exploit that by purchasing call options that have a momentum bias that's not quite that simple, right? But it's effectively trying to capture the momentum components to the top side that are created by a borg-like creature that just buys. It just does it in really simple terms. To the downside, we're exploiting a second feature that has emerged-- and people have heard me talk about this-- the rise of correlation that is created by the growth of passive index investing.
And so there's two features that you should expect-- positive momentum pulse and an underlying increase-- here comes one of my dogs-- an underlying correlation increase that occurs when you have the market move down. And it happens in a much smaller space than people are generally used to. And so if you think back to the black swan, Nassim Taleb's well-known book and the phenomenon that we now refer to, effectively, he was arguing that the distribution in terms of outcomes was mispricing the tail. So the extreme events were improperly calibrated.
We actually think something very different is happening. Effectively, the shoulder is mispriced. And we see that. And that's by and large what actually played out this year. While it felt like this was an extreme tail event, it was literally the minute we punched through kind of the immediate support levels that were created by the positive gamma positioning of dealers, which in turn is created by another phenomenon that has become dominant that you've heard me talk about-- it's the systematic selling of volatility.
The minute we punched through those levels and dealers were suddenly forced to seek volatility, we just shot down. And that's part of the point of the stuff that I've been writing and trying to communicate to people. I actually am very hesitant to ascribe too much of an economic signal to what we've seen. Clearly, this is a catastrophic event. We've also had quite catastrophic impacts-- choices and policy decisions.
What we know is what we've seen in the markets. And I think people tend to interpret that as an economic signal because of the historic role of discounting. I don't think that's what happened. I think this is very much like a 1987. This is a market structure event. I think that's true in fixed income, I think it's true in equities.
RAOUL PAL: Yeah, I mean, it was a liquidity event essentially because of market structural issues. It was everywhere. We've seen it in foreign exchange markets-- the most liquid markets in the world completely shut down for a bit.
MIKE GREEN: Yeah, you and Brent Johnson have talked a lot about the scramble for dollars, and I think that's a very accurate description. And we saw this-- I was having a good conversation with Carl Meyer who runs Silver Rock, which used to be the investment arm of Michael Milken, Carl's brilliant credit investor. Carl and I were talking about this phenomenon.
What we literally saw was every high dollar asset got sold. And the reason why is because people were scrambling for the highest priced thing that they could sell. And so this is particularly true in the credit markets. It just became a question of what can I sell to get the most dollars as quickly as possible? So bond trading-- you sold everything you possibly could at 95, and then you sold everything you possibly could at 90, and then you sold everything you possibly could at 85.
I think that phenomenon absolutely played through, and it was very much like the Lehman-type event. I think that also speaks to kind of where we are in this process, though. I think you and I may differ a little bit in terms of how much this is going to actually follow through and how this is going to play out long term, because we already had this 1987-style event. And what we've seen is something that I had told people to expect. Active managers are the ones that got killed.
RAOUL PAL: Yeah-- which you've always been clear on that that will be the case. And you've, I think, made pretty clear that the passive flows didn't stop in all of this.
MIKE GREEN: They didn't. They didn't. And that's the other thing that people tend not to realize is as much as we've seen unemployment rise, particularly in the United States-- and we have less good data in the rest of the world, it's one of the challenges of, obviously, being a macro investor, is the US tends to be a focus because the data is just so good-- or tends to be so good-- it lags and it's harder to get with any real fidelity as you move around the world. And as you move from developed to developing markets, this obviously gets even worse.
But in the United States, what we saw was very interesting. In this last jobs report, those with college degrees-- the number of employed people with college degrees actually rose. We saw an increase in employment for college-educated individuals. We saw a decrease in employment for those who have less than a college degree, right? All of the job losses, effectively, occurred in the universe of people who are less skilled, incapable of taking advantage of working from home.
RAOUL PAL: So basically the service sector-- restaurants and bars.
MIKE GREEN: The lower end service sector, right? So not your mortgage broker per se, but the restaurant worker, the retail worker, the groundskeeper at the NFL game-- show my lack of attention to sports. We're obviously not in the football season-- but for the NBA, et cetera. Those are the individuals who lost their jobs. And they tend not to have 401(k)'s.
RAOUL PAL: No. No.
MIKE GREEN: And so that's one of the real tragedies. And you've also seen me speak up and say, look, I think a lot of the behavior that we're seeing from the elites-- and I, of course, unfortunately include myself in that-- we're so fortunate. I'm largely unaffected. I work from home. I'm working from my home office. I've got four screens in front of-- five, including my laptop that I'm not working from to do this call. My fish is unaffected. My dogs clearly still love me.
This, to me, is an extended vacation. And I think so many of our peers are sitting in places like Stowe and obviously, you live in Little Cayman, but moving to the Hamptons, et cetera-- this is like an extended vacation. And if it weren't for the fact that the markets were so crazy, I think a lot of people would actually-- I hear a lot of stories of people like, this is one of the nicest things that's happened to our family. We've had the opportunity to spend all this time together. I appreciate that, but I also think it's so tone deaf to what's happening in the rest of the world.
RAOUL PAL: Yeah. It really is. And it's immensely troubling. I just spoke to James Akins, and him and I were talking about exactly that. It's a very uncomfortable balance in this world. And it just makes things worse than they were, I think.
MIKE GREEN: I think that's right. And I think, unfortunately, the way I think about this event-- I was talking to somebody the other day-- the phenomenom-- the phenomenom-- the phenomenon of COVID-- sorry, you can see I'm getting old-- of COVID can actually be thought of as a metaphor for what we're seeing. It's not actually changing that much, it's just accelerating phenomenon.
So while there's a lot of anecdotal stories of young people dying or being affected, we know that they have comorbidities with a disproportionate frequency. It's a disease that is targeting the old. It, effectively, is shortening their lives. It's a disease that is targeting those that had comorbidities in the business world as well. Macy's is likely to fail, right? Many retail establishments that were already on their end game, we're going to see that accelerated.
And so it's part of the reason why I struggled to be particularly bearish on this, because if we actually look at what's happening, it's accelerated the outflows from active management and into passive. It has accelerated the transition from challenged retail to increasingly dominant home delivery services. And the S&P 500 is not composed of Macy's and JCPenney and all this. They're meaningless. They're totally meaningless. If we were to be totally honest about the phenomenon, Google and Apple have become more important in our lives in the last month than they were before.
RAOUL PAL: So last time you and I caught up, you were already looking at, as many people have, the kind of fundamental place investors who look for value, you were starting to sift through stuff and look for opportunities. Talk to me about your framework going forward. Let's say the next three months, and then we'll talk a bit longer term-- but how are you seeing things and what are you looking at?
MIKE GREEN: Well, so there is a very short term phenomenon that's created anytime there's a crash for liquidity. So there was an extraordinary opportunity that was created in the ETF space. And you saw me refer to some of this on Twitter. The extreme versions where what happened with gold miners, where a product GDXJ and a triple levered version of that, JNUG became extremely disconnected from the underlying securities. So GDXJ, which is--
RAOUL PAL: Which you've been warning about for two years.
MIKE GREEN: Exactly. But what was amazing is when that event actually happened-- so you saw GDXJ trade-- and I'm going to use round numbers here-- at a 25% discount to its underlying intrinsic value, right? And so you could have access-- similar to what we see happening in traditional closed end funds, you could have access to the gold miners at a 25% discount via the basket versus what you would have paid if you purchased them individually.
The second phenomenon was that JNUG, which was a triple-levered version of GDXJ, most people didn't understand that that wasn't three times the underlying miners. That was three times GDXJ. And so it actually stayed with perfect fidelity to GDXJ, which meant it was trading at a 75% discount to the underlying securities. So on a personal basis, that's the sort of trade that was very easy to take forward. One of the challenges for us at Logica, because we're a quantitative firm, we're incredibly excited that these types of opportunities have been revealed, and we can now incorporate them into our tool box.
But there was no mechanism to incorporate it into the tool box from a purely quantitative standpoint. On a personal basis, those were opportunities that we're highlighting. And if you look at GDXJ-- it closed, I want to say-- again, I'm going to get the date wrong-- but March 16, I think it closed at $3.50. And I think it was March 8, it was $12. So that was an easy sort of win. An even more extreme version-- and this is where I think there's a lot of fragility that people really need to pay attention to-- was created in some of the fixed income ETFs. In particular, I would highlight the Vanguard fixed income ETF BND. So BND is the US Aggregate Bond Index. It's the old Lehman Bond Index, then rechristened the Barclay Bond Index, now rechristened the Bloomberg Bond Index. Michael Bloomberg eventually wants to own everything.
That product also traded at a significant discount to its underlying NAV. And of course, the narrative that emerges in that environment is you can't trust the NAV. So it traded at a 7% discount to the net asset value of the underlying securities. And the arguments were, well, this isn't a real disconnect of the ETF, this is uncertainty about the value of the underlying because of the natural illiquidity of the credit instruments.
Well, 70% of that index is US treasuries. And so what that meant was that the underlying index-- you knew that 70% was trading par. So the remaining 30% had to account for 100% of the 7% discount that that traded-- in other words, a 21% discount to investment grade bonds as they were trading in the actual market. So those were the sorts of opportunities that emerged. And there were actually leveraged expressions of that.
Now, the reason why those happened, again, is a market structural phenomenon. Lots of registered investment advisors were engaged in yield enhancement strategies. Those yield enhancement strategies would involve something like owning BND and selling puts against BND to enhance the yield. And the argument is very straightforward-- investment grade bonds are low volatility. Therefore, by selling an out of the money put against this, I'm basically capturing free money.
What people didn't realize is that those options reference the ETF, not the underlying. And so all the historical data shows the performance of the underlying, not the ETF. The option was written against the ETF. And so as the ETF starts to trade at a discount to the underlying, the value of those puts that had been sold explodes, which causes the registered investment advisors to suddenly have far more credit exposure and potentially have margin calls that they'd never anticipated, which in turn forces them to then dump the asset, exacerbating the discount for the NAV. And this is the feedback loop that ended up happening. We saw that happen over and over and over again in markets, ranging from bonds to treasuries to gold miners, et cetera.
RAOUL PAL: You and I, we've been around a while. Closed end funds were this game for a long time. 1998, all of the Asian closed end funds at ridiculous discounts.
MIKE GREEN: Absolutely. Absolutely. And the reason why that can exist and why it has existed historically in closed end funds is the only mechanism for closing that in the closed end fund space is for the manager themselves to decide that they're going to buy back their own shares, or other investors to decide to step forward. In the ETF space, you, one, don't really have that option. There is no cash that's being held on hand or ability to lever to buy back their own shares. So they're very much at the mercy of the market-makers.
And the market-makers are very different than they were in the days of Spear, Leeds, & Kellogg, and LeBranche, where they had a contractual relationship that required them to put risk capital up in front of a security