A Conversation with Jane Buchan: 'Who Has FOMO?"}

After going virtual in 2020, due to Covid-19, the 24th Annual Milken Institute Global Conference 2021 kicked off live in Beverly Hills, as well as virtually, in late October. This year, we present a RealClearMarkets Exclusive Interview with Global Conference panelist Jane Buchan.

Jane Buchan is CEO of Martlet Asset Management and former CEO of Pacific Alterative Asset Management Co. (PAAMCO). In 2020, she was named by Barron's one of the 100 Most Influential Women in U.S. Finance.

I caught up with her after Global Conference via telephone for an exclusive RealClearMarkets interview. We discuss women in finance, FOMO and MEME Stocks, Bubbles, alternative investment strategies, and Inflation.

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Question 1)

Altenbach: Hello Jane, thank you for joining us. When we last met a few years ago, I visited your office with David Ranson. At the time, you we're still the CEO of Pacific Alterative Asset Management Co. (PAAMCO). Since then, you left PAAMCO to start a new company, Martlet Asset Management. Could you tell my readers a bit about what does Martlet does? How is it similar to PAAMCO? How is it different? What strategies does it employ?

Buchan: When I left PAAMCO, my senior leadership team left with me, and we formed Martlet. “Martlet’s business objectives are much broader than PAAMCO. PAAMCO was focused on finding attractive risk return trade-offs, but only in the hedge fund space.” Martlet invests across all asset classes, so to not necessarily be hedged. We can be long, for example.

Altenbach: I heard you do liquid alternative investments too, is that correct?

Buchan: “Yes. Everything we're doing is liquid. We do some advising on illiquid, but mostly our direct involvement is liquid.” Martlet does not invest in ETFs.

Question 2)

Altenbach: Okay. Let's move on to women in finance. I know that's dear to you.

In 2020, you were named by Barron's as one of the hundred most influential women in U.S finance, and you've been a promoter of women in the field. Could you explain what have been some of the obstacles that women have had in the industry, especially in senior finance roles on Wall Street? Buchan described three key obstacles.

Buchan: The first is women do not fit the stereotype of an investment manager people have in well-dressed, articulate, and well-educated man. “Women don’t fit this stereotype,” they don’t fit the “mold” even if they too can deliver strong performance.

The second obstacle is that women have to perform better than men to get hired. “This comes from a conversation I had the other day speaking with a very senior person in the prime brokerage business. He mentioned that, just from what he's observed over his more than a decade in that business, women need to perform in the top 10% to get hired, whereas most men need to perform in the top 25% to get hired.”

The third obstacle comes about because of the first two obstacles, in that women are less likely to get the opportunity to be professionally trained.

Buchan emphasized: "I think there's a lot of strategies that can be used to confront that unintended bias. Because I think in most cases, it's very unintended. I think people are doing this without realizing they're doing this, subconsciously doing this.” For example, have people “look at performance records without the firm name on it and then only look at the firm name afterwards. There are ways to counteract it. There needs to be more attention to pragmatic steps that people can take to address the subconscious or unconscious bias rather than just pounding the table and talking about why there's so few women. I'm trying to move the conversation away from ‘there's a problem,’ because I think we all know there's an issue and a problem, the data clearly show it. But what are simple ways of reducing that unconscious bias and making it better.”

Altenbach: This leads me to point out that Forbes recently noted that several studies indicate female hedge fund managers often outperform their male counterparts, and women led firms held up better in the pandemic meltdown that hit bottom in March of 2020. It sounds to me that they might actually be more risk averse than men, which in many ways is a good trait in our business. Do you think there's validity to that?

Buchan: “I'm familiar with the Forbes article. But I don't think there is validity to that. When I was at PAAMCO, we gave a research grant to professors who came out with a peer reviewed, published study that concluded that once you're trained as a professional money manager, women and men perform at the same level.”

Buchan emphasized: “the reason why the women tend to outperform is found by going back to what the individual told me at prime brokerage.” If the women have to be better to get hired, you're going to, on average, have higher quality women. That isn’t surprising.

Question 3) Who has FOMO?

Altenbach: Let's move on to pockets of inefficiencies. At the recent Global Conference, you were on a panel with Michael Milken titled “Common Sense from Uncommon Investors.” You commented on FOMO (Fear of Missing Out) and pockets of inefficiency. And you showed this fascinating bubble chart with MEME stocks.

Altenbach: You stated that traders of MEME stocks do not play by traditional rules and that creates opportunity. How is that? What is a MEME stock and could you explain the chart?

Buchan: Buchan explained that the:

The horizontal X-axis is the change in Stock trading volume (not Option volume) over the past two years and as you can see, it's centered around zero. If you are to the right of the middle vertical line, Stock volume increased.

The vertical Y-axis is the percentage change over the past two years in trading of the Option volume (as measured by the change in Open Interest (OI).)

So, if you're in the middle of that chart (X=0, Y=0), the stock volume and options volume hasn't changed much over the past two years.

Buchan: “And if you're above the middle line, the Option volumes increased. And if you're below the middle line, the Options volumes decreased. You see Stocks everywhere. I've color coded the MEME Stocks which are Stocks that you have a lot of talking about on sites such as Reddit and other sites. They're very retail oriented and they're the Stocks that the average person on the street is talking about.”

Buchan: Buchan explained that most all those MEME Stocks are in the upper right (X>0, Y>0), quadrant of the chart which “means the underlying volume in both the stocks and options has increased significantly.”

Altenbach: Okay. That's an important point.

Buchan: Yes.

Altenbach: Yes. And the size of the bubble, is that the change in Implied Volatility of the Options over a two-year period?

Buchan: Yes. The size of the bubble is proportional to the change in Implied Volatility of the Options over the past two years. A large bubble can be viewed as a window of opportunity. “So, when the bubble is large it is telling me that people are willing to pay a huge amount to get that Option and valuation goes out the window.”

Altenbach: And then Implied Volatility goes through the roof because they start buying the Call Options?

Buchan: Correct.

Buchan: The important thing is that a large bubble identifies a window of opportunity where you can sell Options, but then hedge yourself against those sold Options by then buying the stock.

Altenbach: Yeah. The covered calls.

Buchan: “So covered call writing on MEME Stocks looks to be extraordinarily profitable. And you probably also want to purchase a PUT to protect you on the downside because the implied volatility is really going up just in the calls.

Altenbach: Everybody has FOMO. It's not just retail investors. On another Milken panel, even legendary investor Howard Marks confessed to occasionally having FOMO, declaring he is "human!"

Question 4)

Altenbach: Okay. Let's go on to the next item, rethinking risk. At the 2016 Global Conference, you were on a panel “Rethinking Risk” along with Myron Scholes who made an interesting comment:

“Markets are the only dynamic answer to know what the future is going to hold about risk. Going back to 2008, the levered markets [that's deep out of the money options] of the world were screaming that risks were increasing. Regulators didn't use that information.” Myron was speaking of deep out of the money options.

You took some disagreement with his comment saying: “as a big investor in hedge funds that you would beg to differ in that the Option markets definitely have a lot of information, but they can also be very wrong.” And you've made the point that people adjust their behavior and their rules based on what they saw last time.

Could you clarify your views on the utility of the information to be gained in looking at the levered markets?

Buchan: The disagreement was, if you just looked at the Implied Volatility on Options, you could have seen 2008 coming. There's lots of times you'd get big increases in Implied Volatility, and nothing happens. The market is smarter than that.

Altenbach: Just for the record, Myron was commenting on the deep out of the money PUT Options not all the series. And there's a difference because he says those are more stable correlations.

Buchan: And I would agree. But it's showing risk aversion. It's showing the level of the sentiment of fear. I would argue it shows how much investors think the market is toppy, but it doesn't mean it's going to crash. That's the logic.

Buchan also added regarding the regulators using Option market data: “And I’ve known people at FED and Treasury for over 30 years. I do know they look at these Option markets, and I think that was the other thing that kind of took Myron to task it. Implying that, well, if you just looked at the deep Option markets, you could have predicted the crash and we could have done things about it. I mean, that's a lot of driving in the rearview mirror.”

Question 5)

Altenbach: Nassim Taleb has made a name for himself by investing just a little bit of his portfolio in deep out of the money PUTS. Of course, most of them expire worthless, and he just rolls them over. It's a process he describes as “bleeding real slowly,” and basically he says, if you have patience and you keep doing that and can withstand the pain, the hundred year storm is going to come every 10 years and you'll make windfall profits. That's because the option markets habitually underprice events that are both low probability and high impact.

Question: Have you ever invested with Nassim Taleb or anybody who uses a strategy like he does?

Buchan: We have not invested with him. I met him years ago, and I think he's a great options guy. The problem with this strategy is that it requires a tremendous amount of discipline which most people do not have. You have a problem when you get into a portfolio then three years later the client looks and they'll say, I've bled slowly, I've lost money. My three-year trailing numbers are negative 2% per year or something.

Altenbach: Yeah, they're bleeding.

Buchan: You really have to understand “it's like buying insurance, like buying house insurance. You really have to understand it. And, the difference is when you buy homeowner’s insurance, or at least in my case, I write the check for that once a year, not happy the week I write that check, but then I forget about it and I don't get constantly reminded of it.”

Altenbach: Yeah, I understand. But if you're an investor, you're constantly reminded because as Nassim says, you're bleeding.

Buchan: Exactly.

Altenbach: So basically, you think strategy could work, but very few human beings could withstand the slow pain?

Buchan: Correct.

Question 6)

Altenbach: And the last question, of course, a big theme discussed at Global Conference was inflation. Is it transitory? Most of the consensus appeared to indicate it was. What are your views on inflation and the supply chain?

Buchan: I think there's two fundamental issues here, “Transitory” and “Sustained” inflation. To an economist, transitory has a very specific meaning. And what it means is that any inflation that is occurring is evolving from short term supply and demand and balances. So, we're getting inflation, because people want to buy more gas than we can produce, okay? “Transitory means that it's the market supply and demand that's causing it. And then if you follow that logic through, what happens as the market corrects, you find a way to get more supply into the system and then the inflation disappears. That's why they call it transitory.”

Buchan: “Sustained inflation is when you get things like labor contracts negotiating higher wage and benefits. I'm negotiating wages for a five-year contract, and each year I am going to get my wages increased by 2% each year so you know you are going to pay more for gas 5 years from now.”

“That is, non-transitory inflation because it's baked into the system. The prices are going up regardless of what's happening to short term supply and demand dynamics.”

“I think a lot of the problem with the use of the word transitory here is that when they interview people like Janet Yellen, who's an economist, what they're really saying when they say inflation is transitory is it's being driven by short term supply demand problems.” That's why they completely link it to what's going on with the ports. It's being driven. As such it's not getting baked into the system.

However, “it does NOT mean it's going to go away in two weeks. It'll take however long the market takes to correct.”

“For me, right now, inflation is transitory because it's mostly being driven by supply and demand dynamics, but you're starting to see some of these unions, like the union at Deere negotiate labor contracts, where it's baking it in over several years. And I think that's a very worrisome development.”

Altenbach: Okay. Well, I think we covered a lot and I really thank you for joining.

Buchan: All right. Thank you, Jim.

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