Some hedge fund managers can be pretty generous.
For example, last year Duquesne Capital’s Stanley Druckenmiller and his wife Fiona gave more than $700-million to the Druckenmiller Foundation, while several years ago appaloosa Management’s David Tepper gave $55 million to Carnegie Mellon’s business school.
Dr Sanford Grossman has taken a different approach. Instead of money, the Chairman and CEO of QFS Asset Management donated a minority stake in his firm to the University of Chicago, where he received his BA, MA and PhD, all in economics.
He won’t disclose the assessed value of the stake. But he says: “It seemed natural to return intellectual capital I received at the University.”
Grossman taught economics and finance at Stanford, the University of Chicago, Princeton and the University of Pennsylvania’s Wharton School of Business. When he was 34, he was awarded the John Bates Clark Medal, given by the American Economic Association to the nation’s most outstanding economist under 40.
Today, he runs QFS, specializing in currency trading, fixed income and other macro strategies, taking credit for being the first person to apply Modern Portfolio Theory to the currency markets.
Grossman is also proud to point out that just a month ago he learned that the American Economic Association designated as one of the 20 most important articles in the last 100 years a paper he wrote in 1980 with Joseph Stiglitz – now a professor at Columbia University and a one-time recipient of the Nobel Memorial Prize in Economic Sciences – called “On the Impossibility of Informationally Efficient Markets.”
The principles laid out in the paper, and in his University of Chicago Doctoral Dissertation helped form his philosophy for QFS’s trading—that there is both an informational role of prices, and an allocational role of prices.
It is a little complicated and somewhat esoteric. But his work provided a uniform framework for understanding how prices convey – and sometimes, do not convey – information in securities markets. “A market determined equilibrium asset price reflects both the information of the market participants, but also their liquidity needs and risk aversion,” he explains.
Grossman also says he learned a number of econometric techniques that were in turn applied with Modern Portfolio theory to currency trading. How? Grossman says he draws on mathematical and econometric techniques he learned at the University of Chicago, and then combines them with the insights of an economist. In the case of currencies, he has found that countries that tend to have relatively good economic growth, tight monetary policies and high interest rates tend to outperform currencies where the reverse is true.
“You want to borrow in a weak country and lend in a strong country,” Grossman explains. In other words, shift capital to strong countries. “We quantify this and put it in our Modern Portfolio Theory framework,” he explains.
This entails figuring out relationships between currencies, modeling risk and figuring out how to prevent large draw-downs. “We are trying to create a cross-hedged position, which comes out of a mathematical framework,” Grossman explains.
He’ll typically keep his currency trades on for months, or quarters. His global macro strategy general entails shorter time frames.
As complicated as his methodology is to the lay person, Grossman’s methodology obviously works. The QFS currency program, launched in 1993, has generated a net average annual return of 13.5 percent compared with 10.1 percent for S&P 500 while The QFS global macro program, launched in 1998, racked up a 12.3 percent average annual net return versus 5.8 percent for the S&P 500. Last year, the currency program surged 30.4 percent while global macro was up 13.1 percent.
Grossman stresses both programs – futures and currency traders prefer to talk about programs and not funds for legal purposes – have generated these returns while maintaining very low correlations with traditional as well as other “alternative” investment strategies.
He concedes his biggest frustration of the alternative investment business is that most investors don’t appreciate that getting good returns requires bearing risk. “Prior to 2008, many investors thought that it was possible to invest in ‘arbitrage strategies’ that would always generate positive returns, but they learned that these arbitrage strategies involved high degrees of credit risk and illiquidity risk,” Grossman says. “Investors were bearing a lot of risk; this risk was simply hidden by the fact that the economies of the world were booming. Many products can add absolute return, but are not riskless. Investors should place value on a long-term record that is uncorrelated.”
Grossman says the key to his recent strong returns was correctly determining that US monetary policy was very weak and its fiscal policy was unnecessarily expansive. “Our models picked this up,” he says.
So, he was short the dollar and long currencies he deemed to have responsible policies, though he would not single out specifics. It is known that last year the yen surged in price, while the dollar was up about 17 percent against the euro in the first half of the year but fell about 11 percent in the second half. The first half strength in U.S. bonds was inconsistent with Grossman’s views that monetary policy was too loose, and fiscal policy was too expensive, causing his fixed income program to finish the year down 6.3 percent after racking up low to mid teens gains the three prior years.
Looking ahead, Grossman sees US long rates continuing to rise, a consequence of the government’s QE2, or quantitative easing, which he calls “Monetize the Deficit II.” This is opposite what the Federal Reserve wanted to happen.
So, he expects the dollar to continue to weaken against what he calls “countries doing well.” He sees inflation pressures building up, which is negative for long bonds. And if rates rise, he does not believe the stock market rally is sustainable.
In fact, he believes the only way out of the fiscal problems in the US is for real economic growth to return to the 4 percent to 5 percent rate. “If we do this on a sustainable basis, we can dig ourselves out of the deficit hole and the Fed will no longer need to monetize the deficit,” Grossman says. Strong economic growth would also bring down the unemployment rate. “It is not the most likely to happen, but not highly unlikely either,” he says.
