In this new episode of The Derivative, host Jeff Malec talks with PGIM Quantitative Solutions’ Devang Gambhirwala and Lorne Johnson about managing over $100 billion in quant and multi-asset strategies inside a $1.5 trillion asset manager. They break down the boom in options-based ETFs, from covered calls and defensive equity to buffered and defined-outcome strategies powered by flex options, plus what today’s volatility and rate environment mean for investors. The trio also tackles the impact of AI, fiscal imbalances, and even gold’s renewed role in portfolios. SEND IT!
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Check out the complete Transcript from this week’s podcast below:
Defensive Equity, Flex Options, and the Future of Quant at PGIM
Jeff Malec 00:09
Welcome to the derivative by RCM alternatives send it. Hey everybody. Welcome back to the show. I’m down here in sunny Palm Beach for a couple meetings. Have a great show for you today. I think we have one of our largest managers we’ve ever had on the show. P, G, I m, I gave him a little ribbing for the name. It’s always confused me that name. P Jim had two of their guys on they manage hundreds of billions of dollars, de Vang gala and Lauren Johnson of P Jim here to talk about what they’re doing in the option space, how they think about risks and how they think about generating returns with that big of assets under management. So send it
Jeff Malec 00:52
all right. Welcome guys. Thanks so much for coming on. We are here with Devang and Lauren. I’ll let you guys pronounce your last names so I don’t butcher them.
Devang Gambhirwala 01:02
I’m long Gamber Walla. Lauren
Lorne Johnson 01:05
Johnson, great to be here.
Jeff Malec 01:06
Lauren Johnson, I could have, I could have got that one. And where, where are you guys? Today? Looks like a fancy studio. You got set up there. That’s how it is here in Newark. You’re in Newark. New work, yeah, new work, Newark. How’s that airport situation working
Lorne Johnson 01:21
out for you. Last time I went, it was all right, but yeah, had a few bumps in the road last year.
Jeff Malec 01:26
Yeah, that was a that was a mess, but they got it all fixed up. Seems to be better. Love it. And where do both of you live? You commute to Newark from the city, from the area.
Lorne Johnson 01:36
So devong and I are pretty close together. I’m in Hoboken County, the monks just a little down the street in Jersey City.
Devang Gambhirwala 01:43
Love it. So some, some I see the Statue of Liberty out of my balcony. So it’s it’s right adjacent to Manhattan, downtown Manhattan.
Jeff Malec 01:52
Yeah, we got some of Chicago’s finest driving by me right here. So New Jersey people, you jets or Giants fans, 40 Niners.
Devang Gambhirwala 02:00
40 Niners. There you go. I’m a Dolphins fan, which was to say about that, yeah.
Jeff Malec 02:05
I mean, a little bit better than the New York teams, but not much. Well, hopefully we meet our bears, meet your 40 Niners in the championship game. We both got to get an unlikely win to see if
Lorne Johnson 02:15
we get the same outcome we got a couple weeks back when IERS played Chicago.
Jeff Malec 02:19
Yeah, that was a fun game now. So Devang, let’s start with you. Give us your your role there, and then we’ll dive into your background a little. And then we’ll circle back to Lauren, sure.
Devang Gambhirwala 02:28
So again, Devang Amber wala, I’m Managing Director and portfolio manager at pjms quantitative Solutions Group. I’m responsible for portfolio management for our quantitative equity strategies. And you know, as part of that, I’ve been overseeing all our long, short strategies since the inception about 20 years ago. I oversee our portfolio portable Alpha strategies more recently, but I’ve been with PGM for almost 40 years, so I’ve been here right out of college. So it’s been, been a long tenure. More importantly, relevant to a conversation today, I’ve been managing options based defensive equity strategies for over 30 years, so I’ve seen a few market cycles, shall we say? But seriously, yeah, it’s it’s been a fun ride. I’ve with my long tenure. I’ve seen outlive it to five potential CEOs. We’ve gone through our went from a mutually owned firm back when I joined to having an IPO in 2000 we’re now a listed company. Now we’ve been able to deliver good you know, client outcomes over this period. And you know, we continue to do so again, it’s, you know, what keeps me going is working with the great bunch of people, both colleagues past and present, including Lauren here, and then, you know, our clients who keep us on our toes. So, so that’s that’s been the ride.
Jeff Malec 04:00
What was your role when you first started mail room or something?
Devang Gambhirwala 04:04
It wasn’t exactly the mail room. I actually joined as a summer intern. You know, I was gonna say my undergrad is in Computer Information Sciences here at New Jersey Institute of Technology, right here in Newark. So we basically was supporting the working in an investment area, supporting the portfolio managers running screens, and this is before the PC area. So we’re working with these IBM mainframes, and we’ve come full circle now. We’re back on networks, as you can imagine. Yeah, again, learned a lot, and that’s what got me joined the firm and been there ever since I completed my MBA here at Rutgers University, again, couple of blocks down from us, that famous big
Jeff Malec 04:46
tent school. Yeah, and you predate Rutgers being in the in the big tent, that’s right, Lauren, he’s raised you 40 years. What do you got? Can you call him?
Lorne Johnson 04:59
Not quite. 40 with P Jim, I’ve been in the business a little while. I joined our quantitative Solutions Group in 2018 I’m responsible for portfolio management, portfolio design and multi asset research. Prior to joining our quantitative Solutions Group, I was leading a portfolio management team at State Street, Global Advisors, on the multi asset team there. I’ve also had some stints in the public sector. I was a asset allocation Portfolio Manager with with CalPERS, also a portfolio manager at ABP investments in the Netherlands, where I was doing quant investing, and also the hedge fund where I started out Caxton. So a little bit different road than the Devon and jump jumping around, but I’ve been been with P Jim, the quantitative Solutions Group for this is my eighth year now, prior to coming into the industry, I did my undergrad public administration in history at California State University Chico. So there’s a little bit of an indirect path coming into the business. I did a master’s in economics at San Jose State, and then finally a PhD at the University of Washington in economics. When I started that program, I was clear what I wanted. I wanted to be a professor, and that was why I went into a PhD program. That’s kind of what you got to do if you want to be a professor. As I worked a lot with data. My my dissertation was essays in empirical economics, I found I had an aptitude working with financial data, and that put me on the road to doing interviews with with different firms and asset management. And I’m very grateful that that’s where I’ve ended up.
Jeff Malec 06:41
Are you grateful they ripped you away from the beautiful West Coast and put you in in the metropolis?
Lorne Johnson 06:48
I did get back out there for a little while when I was with CalPERS. I was Sacramento, but it just seems that life has taken me here. Spent most of my professional career here on the East Coast, both in Boston and now down here in the New York, Newark area. Love it down here. Actually, I imp New York before, when I worked at Caxton, lived in Brooklyn, so was excited to have the opportunity to come back here.
Jeff Malec 07:12
So CalPERS might be the only thing nearly as big as as P gym, right?
Lorne Johnson 07:18
Well, where I work, that was kind of on that scale of CalPERS that it’s not as well known here, but that’s a Dutch pension fund.
Jeff Malec 07:35
So let’s talk about P Jim. Give me the rough history, I gotta say, and hopefully this doesn’t upset the compliance. But what’s with that name? It’s always rubbed me a little bit the wrong way, right? When did you switch to P Jim? Was like, six years ago,
Devang Gambhirwala 07:48
yeah, something like that, maybe, maybe 10 years ago, right? You know, financial investment management, but you know, yeah, I know. P Jim. Just quick overview. We’re, you know, we manage 1.5 trillion in assets. We’re the global investment management business of Prudential, apparent building of a legacy of 150 years. You know, we celebrate 100 and 50th year as a firm last year of, you know, stability, strength and discipline, risk management as part of our insurance legacy gone over. I don’t know. I’ve gone through five market cycles, but as a firm, we’ve gone through probably 30 market cycles over this period. And our pjms global client base includes public and corporate pension plans, foundations, endowments, sovereign wealth funds, multi employer pension plans, and we also sub advice. We have sub advice accounts with many other financial service firms.
Jeff Malec 08:48
So yeah, it runs Prudential insurance premiums as well, like prudentials, cash or No, it’s all outside clients.
Devang Gambhirwala 08:56
No, we manage both the money for our affiliates within within the Prudential family, but yeah, and third party
Jeff Malec 09:02
assets, it’s going to stretch my when I was on the trading floor, I can’t remember the sign for Pru something like this, but Right? Pru had what they called him, Prue, first of all, but they had was a little facial sign that would be the signal for prue’s Buying 500 or whatever. So what’s it like? Right 1.5 trillion in assets. The quantitative group is about how much you’re managing.
Devang Gambhirwala 09:26
So you know our features, you know what we now are, the quantitative Solutions Group. We manage over 100 billion in, you know, in institutional client assets. And you know, across both our quantitative equity platform and our multi asset strategies, and we manage against a whole wide range of benchmarks, domestic and international. So yeah, pretty, pretty broad footprint in terms of what we do.
Jeff Malec 09:49
Yeah, but I’m saying like, do you ever wake up and pinch yourself and be like, $100 billion right? Do you get you look in the mirror every now and then and be like, this is a huge responsibility, or it’s just like you, you. You’re just adding a zero, you’re adding more shares, you’re adding more contracts. It doesn’t really bother you in the quant sense, but,
Devang Gambhirwala 10:06
yeah, look, I mean, we’ve, yeah, we’re institutional money managers, so we manage, you know, huge pools of money, but you know, we’re fiduciary, so we take, you know, our responsibility very seriously,
Jeff Malec 10:16
yeah, but it’s interesting to me, right? 150 years all that money institutional, I’m sure you’ve been called boring and right. But here you’re doing, not you personally, but the firm right. Here you’re doing quant. You were early to quant. You’re doing long short. You’re doing defensive equity. You said, you mentioned portable alpha. So how do you kind of square those two things? Lauren, I’ll let you jump in. How do you square like that, being that fiduciary, being very risk controlled with moving into kind of more, I won’t say, esoteric. It’s pretty broadly used across the space now, but at a time right was a little niche at the time. Yeah, well,
Lorne Johnson 10:51
quant can mean a lot of things. I mean high level quantitative investing is a systematic approach, often using models to transform data either in a cross section or over time, and making decisions based on that. And in contrast to a fundamental manager who is looking at information and kind of making a call, it allows you to work with a lot more data in quant space, its breadth is our friend. In our quantitative equity space. We’re looking at 70,000 different stocks, but we’re also doing quant on the multi asset side, just in terms of the spectrum of what could be considered quant. There’s a side of the spectrum that could be called sort of quantum mental people look at models information and okay, they’re informed by some systematic process, but ultimately there’s more of a human element, and then there could be pure systematic that’s it’s all, all model based. I’d say what, what we’re doing, is more towards the systematic, but you always need human intervention. And what is a model? So I was just looking at dictionary this morning, right? Well, there’s seven definitions for model. Let’s put aside different types of cars or or fashion. A model is a simplified representation of a system, which can be very powerful, because it can lead you to some inferences and answers very quickly that you couldn’t do without that systematic framework. But ultimately, models will miss things. And so it’s very important that you have a human at the controls to evaluate the information and to know something may be going on that’s outside of the model. And also part of quant is risk management. So there’s, hey, what can I do to beat a benchmark? I’ve got these great factor models. It’s also very much about risk management. And frankly, a lot of what we do in the quant space may not even be about Alpha. It’s about delivering an outcome based on somebody’s risk preference. It’s a broad spectrum. What’s quant to your point? 3540 years ago, there wasn’t a lot of quantitative investing. The early movers, including the PGM quantitative Solutions Group, took advantage of that. But as more players come into the space, a lot of the anomalies that you can make money on, they go away. So you constantly have to innovate. And now we’re in this age of AI, which is kind of a supercharged version of what quant was before, is the amount of information that you can process and do things with has just leaped from those those early days where it seemed just amazing that you could take information on 1000s of stocks and come up with a combined view. Well now we’re we’re looking at things like natural language processing, where you’re processing millions of words coming out in news releases and saying, Hey, there’s information there that can inform my quantitative process in real time. Just closing the loop on what does that mean using that information I talked about looking at it over time. There’s also how quickly you want to use that information, so you could trade once a month, and perhaps with the right amount of information, that’s fine. And that goes all the way to quantitative strategies trading intraday or vol control strategies that are evaluating the market every few minutes to see if in my position, where I want to be in terms of an exposure basis. So always could go on and on different types of quant.
Jeff Malec 14:23
I love it to follow one things, one follow up. You viewed each of you personally. Do you view it as a solvable like, is it a clockwork machine you can put back together? Or is it forever unsolvable, and you’re just trying to get as close as possible with the model? It’s probably closer.
Lorne Johnson 14:39
Yeah. Yeah. Yeah, you know, I wish it was as simple as, you know, we’ve got it figured out here, and we could just run the model and, you know, let it go, and it’s going to deliver us a positive outcome every day. Does? This doesn’t work like that. And as I alluded to earlier, the model is great, but it can’t have everything in it. You know, there are the black. Swans and things that happen. So you need a human at the helm when something that Nobody’s expecting happens, and that’s often a risk control exercise, right? Let’s, let’s take our risk down until we get a little bit better picture here things that are outside of our models. So, you know, again, there’s a balance. If you think about the quant as a science. There’s an art into how you’re going to use it in your investment process.
Jeff Malec 15:25
I was going to you stole my thought there. Of like, is it a constant Red Queen race, right? Of like, you have to be constantly moving. Like, it’s not about creating a new model. It’s about fixing the old one that stops working. Or right? There was some research a couple years ago, of like, once a factor becomes known, it’s basically no longer a factor, right? So how do you guys protect against that? Of like, hey, we came up with this nice thing, but do we publish it? Do we tell our clients? Do we not tell them? So it remains as viable as possible? Whoever wants to jump on that grenade, go ahead,
Lorne Johnson 15:55
I threw that out early that Hey, back in the day quant investing, I’d say it was easy, but the kind of money you could make just having a simple model of four or five factors is a lot easier than it is today. So indeed, once people know about the anomaly, it can be arbitraged away. So you got to be a step ahead. We’re doing something a little different. It may not be that the concept that you’re using is so far removed, but maybe your transformation of the data, or the speed at which you’re incorporating the data, and that’s very much a theme today, the way that complex information can be brought together in real time some older quant models, maybe you have to wait until the quarterly earnings release for some of that information. Well now you can listen. You can analyze 1000s of news stories and and come up with a signal every day that’s giving you some of those fundamental insights.
Jeff Malec 16:50
It seems to me, randomly that people will start to go backwards, like, Hey, let’s go dig up the old models from the 60s and 70s and see if anything’s working. Or let’s slow everything down. And maybe that works better.
Lorne Johnson 17:01
Everybody’s abandoned the old stuff because they don’t think it works anymore, and maybe now you could, you could start again.
Jeff Malec 17:17
Let’s switch gears a little bit. Debunk. You’re a options Pro, is that fair? I mean, 40 years with one of the largest asset managers in the world, come on, give yourself a little credit. So there’s a lot of buzz in the industry. A lot of people are doing alternative income, which is really option strategies, buffered, covered, calls, all this stuff. Tell us a little bit about your how you’re seeing the whole space kind of has grown up in the use of options and how you guys view it,
Devang Gambhirwala 17:44
not as commonly used at Big exposure. But, you know, as you can see now, with the kind of proliferation, essentially, of options based strategies, primarily through ETFs, this what was available to a few is now broadly available to a, you know, much wider investor base, right? And ETFs are truly, you know, democratized. All those you know, active ETFs are having a moment now, right? A lot of the flows are more inactive, as opposed to what we saw over many years of passive index ETFs, for example. But now, a lot of the right, the money flow is, is in the activity apps, and the fastest growing segment of that is options based strategies, and they’re trying to whether it be for income or whether it for, you know, limiting your downside. And you know,
Jeff Malec 18:31
do you have any worries that it’s too democratized, right, that people can chase Gamestop up and put their whole paychecks in there and do a lot of stuff that maybe they shouldn’t be doing without the 40 years of option knowledge, right?
Devang Gambhirwala 18:44
You know, like, don’t try this at home, right? I mean, you know, yeah, but they are, but they are like, I mean, there’s a whole class of, you know, of investors now who do a lot of things at home, you know, in front of five, you know, three screens, and they have their real time fee. But you do need to understand, kind of the you know, how it’s not all. You know easy and you know, you have to be mindful a lot of things. You know, options, by their very nature. You have to be mindful of the risks. A lot of people get into it and saying it’s just a one way lottery ticket, right? Like, yeah, leverage it, but yeah. I mean, it comes with the risks. It really helps to understand options, the systems, the scenario analysis, for example, and really understand option payoffs and how they work. It’s a great tool to have to have add more flexibility to what you do in your overall portfolio, but you don’t want to bet the farm on a stock or an option given stock, right?
Lorne Johnson 19:42
Yeah, one thing I would add is there’s a perception that maybe one is not very familiar with how these popular option strategies that Devang alluded to, particularly in ETFs, work thinking that well, options are very risky. Right? And you could certainly take crazy risks. You could write a naked call, which means, basically, you’re going to pay for any amount. The market would go up. In theory, the market could go up 1,000% and you’d be on the line for that. Most of the strategies that have attracted the Aum and the ETF space have been strategies that actually manage risk, that reduce risk, relative to, say, a long only investment in the s, p5, 100. So the options are allowing you to target these more specific outcomes in a way that was not available, as devong mentioned, say, even six, seven years ago, that most of this growth in in the active ETF space and options based strategies really just happened in the last several years.
Jeff Malec 20:50
Put your tin foil hats on of what? What could go wrong there? Right? Could the tail wag the dog? Could options become bigger than their underlying that they’re supposedly representing, and things get a little wonky. So keep seeing this growth,
Lorne Johnson 21:06
observing both the the option space and the ETF space. What’s interesting is there’s no fixed supply the way there might be an individual security. So because it’s so straightforward to create a derivative on something, there’s not a limited supply that there’s just not enough options out there, and the price is going to go up. They’re actually the mathematics behind options are such that you can price them very, very precisely. And I would not be someone to say that, you know, too much money goes into something, that there could be, be some some risks that are created there, but it’s unique in this flex option space, where, where the options are created and also taken out of of circulation if the demand isn’t there. Similarly, ETFs are something like that, that they are ways to invest in something underlying. And if I come in with a tremendous amount of money to buy a particular ETF, an option based ETF, for example, there will be shared of on a derivative there exactly, there will be shares created. So I’m not chasing something that’s in fixed supply, so there’s not going to be a distortion in the market with that. On the flip side of that, if I want to sell out of that position, the shares will be redeemed and come out of the market, and the market will be back in equilibrium in terms of supply and demand. Again, I will be the last person to say there are no risks on anything. But as it comes to options, particularly flex options and the ETF ecosystem, it’s very self equilibrating, and in many ways, is less risky than what you would be doing going after a specific commodity in fixed supply, or specific stock in fixed supply.
Devang Gambhirwala 22:53
Lot of it, kind of the kind of the products we see out there, a lot of it are on like these broad based indices, like the s, p5, 100 index or the NASDAQ. These are, as you know, broad and deep markets and the largest in the world, so that that kind of eases some of the concerns. Now you go after kind of, you know, less traded stock that’s very volatile, and then you buy an option or ETF on that. That’s a different story, right? That’s not where the growth is. The growth is in these, you know, let’s say s, p5, 100, or NASDAQ, kind of based products, which is where most of the we see all the asset flow, right? And there you can tailor things and, you know, to meet specific outcomes, as Lauren pointed out, but there’s significant liquidity in that, right? In kind of the especially in the US markets, these popular indices. And not only in, you know, you know, in just underlying, you know, index investing, but in the option space, in the future space and the swap space, you know, so there’s extreme liquidity there. And we’ve been trading these, you know, let’s say as SMB, 500 index options. And now, you know, SB, five the ETF options are equally liquid, if not more sometimes, yeah, very broad and deep markets. We get very tight quotes. If we go out to quote, you know, an option price, whether it be, you know, one month 10 or it could be, you know, five year tenor, we see a lot of breadth and depth and a lot of market participants, as I mentioned, from brokerage firms to hedge funds to, you know, retail investors. So again, not an issue at this point. So you know, the market can easily absorb kind of the products that we’ve been talking about.
Jeff Malec 24:33
And do you guys model that this flow like, has that become a new input of, like, all this new retail ETF flow into those options, like, either from an execution standpoint and or, like in the models themselves, of like, this is showing us we’ve got support or resistance, whatever.
Devang Gambhirwala 24:50
Yeah, I mean, whenever we have to go out to trade, you know, an option, or, you know, a pair trade, we’re buying and selling something, or we’re quoting a. Something for, you know, for a buffer, ETF, or what have you we see the, you know, lot of participants, and that’s one sign. So there’s enough market interest and market makers who are making markets in these and then the pricing. You can see it whether you’re buying, you know, you’re buying something for 10 million, or you’re buying for 100 you know, again, so you see it in the both in the liquidity numbers that there’s no issue, and in fact, things have improved, I would say, in terms of liquidity and the kinds of things you can get pricing on, there’s a lot of market participants, a lot of market interest. And that’s not because things became more profitable. In fact, there’s a lot more competition in that space. So we like all the growth in the options space.
Lorne Johnson 25:43
Yeah, one of the indicators, sorry, go ahead. I was just quick. One of the things that we see in our research in pricing options is that, and it’s an indication of just how liquid the market is, the spreads that are on options, that are that are traded, have narrowed to almost nothing, especially if it’s something, say, close to at the money with the horizon of, say, a month to a year. There are more and more players coming in to serve this space, to play both sides right, to buy and and sell options, so you can go out there, whatever side you want to take, and somebody’s on the other side to provide liquidity.
Jeff Malec 26:20
This is a little wonky, but have you seen it affect volatility pricing? Like, is it dampening volatility, all this new volume into the tabs? Like, artificially? So we maybe could argue,
Lorne Johnson 26:30
I’ve heard that argument made that the apparent volatility in the market is suppressed because so many people are going in and participating in the these strategies. I don’t think the world’s changed that much. We saw in April, the VIX spike to 80. Risk didn’t go away. There was a lot of uncertainty at that moment. It’s calmed down a bit. If something comes into the market that is at odds with people’s expectations or their view of the near future, that is going to change behavior. We can see vol spike, and that’s going to pass through into option markets.
Jeff Malec 27:03
Absolutely, I’d argue what’s happening is there we’re getting fatter heads and fatter hit, right? So it’s like we’re pushing all this vol, we’re getting rid of all the normal volatility with all this option and market making, and we’re kind of suppressing the normal down. But what happens that makes that April move volatility goes up that much higher when it does happen. But that’s my pet theory.
Devang Gambhirwala 27:24
I mean, you could argue that right, a lot of these options selling may tighten the VIX. And people have argued the VIX is no longer the, you know, the fear indicator, yeah, kind of the growth in all these covered call writing, or, you know, put writing, call writing. But as we touched on earlier, I mean, when uncertainty raises his head, or is, you know, market moving event? Yeah, you will see it in malls, I mean, and the VIX is just one month, kind of, you know, right? An aggregation of, kind of the risk. And we look at that indicator as the be all and end all. But even if you don’t see it in the VIX, you will see it when you’re trading in the market.
Lorne Johnson 27:57
And some would say that risk has been overpriced in many ways, and that’s really a reflection of three years of equity markets. And that, you know, why would I buy? The cost of protection is still high, but that the reality is that, well, the market is, you know, just going up. But of course, that I’ll predict will not happen forever, yeah.
Jeff Malec 28:19
Well, you could argue there the relative cost to those people who’ve made so much money is not that high, so the absolute cost is, yes, it’s still high, but the relative cost isn’t.
Jeff Malec 28:40
Before we finish up on options, can someone give an example of a flex option, like an actual what it would look like, just for the listeners who don’t know exactly what that is, I’ll put my hand up as one of them. Yeah.
Lorne Johnson 28:51
So options have particular characteristics, so a strike price is what the level of the option is. So it will, it will determine whether you’re going to make money or lose money on an option. If I buy a call 5% out of the money, and the market goes up 10 I’m good by 5% so that that strike price is, is a term of of the option, the maturity of the option over what term is it? Is it one month? Is it one year? Then the type of option European or American. European option only is exercised at the end of the life of the option. American option you can exercise early. And then now there are, there are options to cash, settle or not. So these are all conditions of an option contract. And on a listed option, there are some limitations that there aren’t options at every single maturity that for a week out, or a week and a half out or five years out, won’t necessarily be available or at a particular strike. Now, what the flex option allows you to do, I can go to the market and ask for the terms exactly that I want. And these are. Very important for things like defined outcome, where there’s a specific amount of protection that I’m looking for. I want exactly 20% downside protection, and I want it for one year, and I want a European option, and I want to cash settle, and I don’t have to go and look at the listed option, see what’s the closest thing for me. I just go straight to market with that. And that’s how the flex works. And then it goes
Jeff Malec 30:23
like, if the S P is at 6943 20% of there is some weird number that’s not the exact, right, 6200 strike or whatever I need a 6216
Lorne Johnson 30:36
I just calculate what that is. And that’s that’s going to go in my order exactly that level.
Jeff Malec 30:41
So it should be called custom options, not flexible options. That’s, I guess,
Devang Gambhirwala 30:45
essentially what they are, I mean, and I can trade it. I mean the additional duties, I can trade it. And, you know, Delta just to the close, meaning I can trade it at 3pm and get the close at 4pm and they will adjust the strike accordingly. So, yeah, again, there’s a lot of innovation has gone into the even in building out the flex, flex option platform from the exchanges and the dealer. So it’s really great, yeah, where you had, like, 123, months, six months, you know, standardized strikes and maturities, and then, you know, things launched on the third Friday of the month. Yeah, with Flex, you don’t have to rely on all that. And that’s why we’ve seen that explosive growth. So when we can customize it, and you can say, I want to start at the beginning of the month and the year Exactly a year later, or however you design a product, and that degree of freedom has been very important options, they still behave and all do the same things, whether it’s call or put up this kind of customization as again, really open up, you know, lot more opportunities for folks to design products and
Jeff Malec 31:45
match what, who’s on the other who’s on the other side of that, just the primes.
Lorne Johnson 31:49
That’s where I was just going to go. The great thing is, you actually have virtually no counterparty risk, because after that flex option is created, it’s listed on the OCC website, option Clearing Corporation, essentially, your counterpart is the OCC, not whoever came in and filled your order. So it’s, in some ways, well, it’s, it’s certainly less counterparty risk than if you do an over the counter transaction with a bank.
Devang Gambhirwala 32:15
I mean, this is why we started, kind of starting investing in Flex options, back when we did in the mid 90s, full transparency, right? It’s listed. It’s fungible. It’s not like an OTC option, where I buy from counterparty A and then I’m locked in with them, and exchanges price some daily. The end of the day, you can get a quote from multiple brokers. So yeah, it’s it’s really been very, very helpful, and I think everybody in this ecosystem understands, like, why that that’s beneficial, not just for everybody, but, you know, for the end investor target, a specific date and kind of an outcome makes it a lot more predictable,
Jeff Malec 32:53
though, that’s really fueled the growth, also of the defined outcome, the buffers of how absolutely can put those together, right?
Lorne Johnson 33:01
And more and more product is coming out all the time with different terms. So a simple version of a defined outcome, 10% buffer, right? You’re protecting the first 10% of your losses. There’s a cost to that, so you’re going to have an upside cap. Let’s say it’s 15% on that 10% Well, you’ve got other variants that have come out that offer 100% protection. You have different outcome periods, three months, six months, two years. And by the way, these are very similar to a lot of products in the insurance market, which I won’t, I won’t get into, which are also hedged with options. And so with the flex options, right? I can come up with anything. And I don’t have to go see is that available in the market. I can create it.
Devang Gambhirwala 33:46
I know we touched on it, but the counterparty risk is a big is a big thing. I mean, when the OCC has gone through all these market crises in the last, you know, at least, I know in the last 40 years, you know, has made good on every contract so there’s no failure you’re not worried about. You know, counterparty not being around, you know, five years from now or not, not, not getting your payoff.
Jeff Malec 34:09
Really very important. You’re in court for two years fighting over it or whatever.
Devang Gambhirwala 34:13
No, I mean, that’s, that’s a big advantage that’s helped with the whole growth of the options and the flex options. You don’t have to do what, again, many investors you do in the OTC market back then, and it was, again, very limited, institutional clients. You take the paper of a Counterparty. None of that. This is all exchange traded, exchange listed, transparent that that’s really been
Jeff Malec 34:35
helpful too. Are you still seeing the demand and the want from from your clients for what I might call, like, classic option protection, right of like, steep tail downside protection, asymmetric. I can spend one 2% a year and get that huge payout if, if, what Lauren said, might one day happen again, right?
Devang Gambhirwala 34:55
Look, I mean, I’ve gone through the, you know, the GFC, the big market, the S and P. Was down over 50% over that year and a half period. Yeah, offensive strategies can approve their mettle right at the time. So we, thankfully, we haven’t had a big drawdown like that since. But we’ve had, you know, things here and there we had the covid kind of drawdown. Was a sharp and that’s the other thing. Things move very quickly now, you know, doesn’t take, you know, 18 months, 20 months, to get from peak to trough. But now it can happen in a month. We lost 34% right in those 35 days in February of 2020, so, yeah, any any strategies that you have in place that can protect on the downside or way to draw it out less ground for you to recover? Now, we had a sharp recovery, but again, some of these products and strategies we’re talking about, they’re adaptive, right? So they’ll they can protect on the downside, but then they can also participate on the upside. So that’s, again, one of these nice kind of features of these products, a side benefit is, like, you know, these products allow you to remain invested in the market, so you’re not right, coming out at the worst time, at the bottom, and then you miss that whole kind of rebound. So that’s another benefit that these products offer, so you remain invested, which we know is good for you in the long term as an investor,
Lorne Johnson 36:12
yeah, I would say that for the current environment, if one is concerned about valuations, we’ve had this big run, but the you don’t want to walk away from this, this big rally, but you do want some protection on the downside, so that that asymmetric convexity, that means, hey, I’m going to participate more when the market’s going up and less when the market’s going down. And a long, dated call option gives you that that profile, and if you were invested in such a strategy, then, yeah, you’ve captured a good amount of what’s gone on the last three years on the upside. But if something happens and there’s a shock, it’s adaptive. It changes its colors. It times the market. For you,
Jeff Malec 36:54
how long dated Are you seeing most interest in that being so we see
Lorne Johnson 36:59
the best convexity outcomes, investing about five years out
Jeff Malec 37:03
and but then they have to
Devang Gambhirwala 37:05
write, like, like, like a car, maybe take it off the lot. Just start dropping the decaying instruments, as you know. So if you the reason you go out further in terms of the tenor is to prevent that time decay, which you know, like, if you buy a five year option, as long mentioned, first couple of years, the time decay is minimal, so you’re still able to get all the benefits of having, let’s say, a call option, but without having to worry about time decay eating away the value of your option.
Jeff Malec 37:30
Yeah, and then you’re rolling it before the before the theta kicks in. Oh, I was gonna say, I wanted one of you to say, like, Oh my God, all of the clients are giving up on their tail risk, and this is a huge signal. But no, there’s no nothing like that. Of the clients seeming bored or complacent.
Lorne Johnson 37:47
If one is following the flows in these defensive strategies, they just keep going up and up and up.
Devang Gambhirwala 37:52
I mean, you know, there’s enough kind of quoting, you know, uncertainty and risk out there, right? I mean, you know, pools are good, earnings are good. The economy seems healthy enough, maybe not for everybody, but generally, can see in the markets don’t necessarily follow the economy, but they’ve been doing well, but yeah, we have stretched valuations for some time the equity in the least in the US equity space, we’re seeing data issues inconsistent, especially with the government shutdown recently. So that adds a level of uncertainty, uncertainty from policy and rate risk. You know, what the Fed going to do or not going to do. And then, you know, then, of course, now the geopolitical kind of tensions going to add to the mix. So again, you know, shifts from the administration, what have you. There’s a lot of things to, you know, maybe keep you awake at night. So strategies like what we’ve been talking about can definitely take some of that uncertainty out of foreign investor while not necessarily being out of the market, right? So you kind of kind of kind of hedging yourself, if you will, wait
Jeff Malec 38:55
there’s geopolitical tensions. I didn’t know about this the you mentioned something offhand before, but I want to circle back to it. Of like that. Sometimes you’re not trying to get alpha, which seems like a weird thing for an asset manager to say, but kind of explain that. And what’s the other side of that, just matching a benchmark or giving their defined outcome,
Lorne Johnson 39:15
you know, thinking about the range of products that are out there. So a lot of these defined outcome products, I mentioned that are fixed outcome period, right? So the guarantee that you’re looking for whatever protection level and the terms of of your upside are provided at the beginning of each outcome period. You can scan across the now multiple offerings that are out there and decide, well, given my objective look, I’ve got almost everything I need saved. If I can squeak out another 5% that’s great, but I sure don’t want to lose any money. So what product offering out there lines up with that the best, whether you’re about buying a boat or you’re financing your kid’s college or something like that, buying a home or down payment right now for longer. Term investor, maybe that that simple, defined outcome is an ideal now, the the strategies will reinvest. It isn’t as if the ETF goes away at the end of the outcome period. It’ll just reinvest in a new term. But there’s some risk there. What is the outcome going to look like then? Or do I even want to bother having to time that there are products that are called ladders that just invest in, say, 12 monthly vintages with one year outcome periods. That’s one way that you can kind of smooth it out. Or maybe you would want something like these asymmetric convexity strategies that are more set and forget, and there’s none of that timing involved. You’re uncapped, which over longer bull markets is going to matter a lot, that you’re going to be able to participate more on the upside, and then you’re not resetting the outcome period. So the downside protection in an extended drawdown just continues, because we talk about the Delta, right? It’s like your beta. How much are you exposed to the market? Well, in a down market, you’re going to participate less and less in the drawdown, and your ultimate drawdown is going to be a lot less than even what’s a fixed drawdown, say, in a defined outcome.
Jeff Malec 41:10
Does anyone ever worry we’re becoming too smart at all this, like we’re going to take all the fun out of investing, right? Or does everyone does it? Every everything just converts, converges to the risk free rate because we’ve taken out all those. I think
Lorne Johnson 41:24
there, it’s almost limitless the number of offerings that you can do in the space, and it’s evidenced by new ETFs coming out almost every week in this space. So defined outcome or income offerings. So we didn’t talk a whole lot about it, but you’d mentioned covered calls earlier, that’s over $100 billion space in ETFs from basically zero just six years ago. And there’s a lot of different variants there. But is it a specific level of income you’re looking for, or you want a certain defensive profile? Because these covered call strategies are also defensive strategies, and you could take a lot of risk. So there’s doing a cover call in the s, p5, 100. And then there are single stocks that there are ETFs that have cover calls on, on single stocks. Now you are taking on a lot more risk there. I would kind of move that off the category of almost everything that we’ve been talking about here today, which are generally risk reduction
Jeff Malec 42:20
strategies, yeah, and I could zag on that and say, just do less stock, right? Just instead of owning 100 shares, do 50 shares, and you’re equaling your covered call. And you can go put that extra money in some income producing thing. But people love them. I agree with you.
Lorne Johnson 42:37
You can lie with the flows. You Hmm.
Jeff Malec 42:48
So let’s talk a little what you guys see. It’s always funny, right? Because if you think the world’s gonna end, you’re not shifting all your models, right, your quants. It’s quantitative. But still, I want to know your opinions of what you see for the rest of this year. We’ve kind of already talked that it’s high valuations, you political, all that good stuff. Whoever wants to go first jump on the 26 outlook?
Devang Gambhirwala 43:11
Well, I you know, I mean, we’ve had Rochambeau, yeah, three good years in a row in terms of the US equity markets. And now we’ve seen both, you know, IFA and markets, you know, developed and emerging markets, kind of catch up in 25 and kind of outperform the US market. So that’s, that’s good. So there’s a little bit of a broadening out of of,
Jeff Malec 43:32
which was like the first time that happened in many, many years, right?
Devang Gambhirwala 43:35
Many, many years, right? So, yeah. So, you know, again, we’ve always believed in, you know, diversification. So that’s, that’s finally, that’s kind of paying off, as opposed to, just like the Magnificent Seven kind of that we’ve seen a run for the last many years. Yeah, you know, again, you know, with AI or, you know, new tech, technology, what have you, I think, kind of coming more and more into fruition with every passing year. So there’s, there’s opportunities to participate in all the benefits we still believe we should be have, you know, fair amount of exposure to equities, you know, mindful of all the uncertainty and risk we touched on, on the interest rate front, things are a little more uncertain, right? We’ve had our cuts from the Fed. Going forward, we’ll see how, how we do on the inflation front, and you know, if any of these other risks kind of pop out and kind of influence the direction of the Fed going forward. So, you know, you can be a little more cautious on the fixed income side of things, shorter duration, in terms of kind of limiting risk. But, yeah, I mean, I think, you know, in reference to all what we’ve been talking about, I think those kinds of strategies that kind of limit your risk make sense, again, for the benefits of not being out of the market or trying to time the market. And you can get these fairly, you know, fairly cheaply in terms of, generally the fees has become a competitive market in terms of what the ETFs are priced at. I. I think we can, from my seat, I can just see continued growth in this options based ETF space.
Lorne Johnson 45:09
So our multi asset team view is similarly constructive. So that would mean maintaining exposure in risk assets, although cognizant that there continues to be policy uncertainty. The market is rich, maybe thinking beyond the context of a calendar year, right? There are some interesting themes that we’re paying attention to. So for one, profligacy and government spending is not just a US thing. It’s global. There’s a lot less talk to discipline and maintaining budgets and things, and we’re seeing kind of an explosion everywhere in fiscal spending. Now that was one thing. When interest rates were really low. A few years ago, they are a bit higher, even though the Fed is cutting, and they’ve come down a little bit and then around the dollar. So the the move to raise tariffs and so forth, at least initially, there was a pretty violent reaction with the dollar selling off and concerns that people would dump their their dollar assets. That that has been allayed a little bit with some of the initial tariffs being rolled back, but we are seeing some interesting things outside of what we’ll call it, the most traditional assets. So precious metals setting new records. You know these, these are trades that could be interpreted a number of ways to address a geopolitical risk, but I think of put silver aside, which is just going up like crazy, but gold as something of the alternative currency, right? And if you think all currencies are going to have problems because of this UNSUSTAINABLE fiscal stance and that that everybody’s going to have to debase their currency, well, there’s gold, which has a fixed supply. I would have never bought gold years ago, but actually, I don’t think it is such a bad thing right now, given the concerns about the fiscal situation globally,
Jeff Malec 47:07
and does that include, I mean, you do see some ETFs that are including gold in Spain, right? They’re following the market, but Right? You view it as a defensive asset. In that way, it’s kind of a different as you said, it’s for inflation, for debasement of the currency, but,
Lorne Johnson 47:21
yeah, I don’t see it as a traditional asset class play, where, for instance, if you’re buying stocks, you’re buying future earnings and you want to participate in that. If you’re buying a bond, you’re buying a contract, basically that you’re going to get paid a certain coupon. Gold doesn’t have any of that, but historically, it has played a role of either being explicitly something that backed currency, or now everything’s on a fiat currency. It’s the alternative currency.
Devang Gambhirwala 47:50
So safe haven asset has become it’s kind of like, would we still look at US Treasuries, but yet this is kind of a proxy.
Jeff Malec 47:57
And so now you’ve led me to Bitcoin. Any exposure there at p Jim, or do you still that’s too, too risky, and do you think of it as a safe haven?
Lorne Johnson 48:07
Our multi asset team is not allocating to crypto
Jeff Malec 48:10
full stop, or because full stop, we won’t wade into that quagmire. I think that’s it. You think we’ll see buffered notes or defined outcomes on gold? Right? There’s probably some ETFs already coming in,
Lorne Johnson 48:23
treasuries already in a product that’s out there. Absolutely there are more niches to be addressed in this space. So to the extent people identify risks and a particular broad asset class, and this is a way to hedge that risk, I see no reason why you wouldn’t see more product being offered on more exposures. You’ve seen it with inequities on different indices. You know, the most money is in products on the s, p5, 100, but there’s, there’s a pretty substantial amount of money on the NASDAQ, and a lesser amount and international stocks and things like that. So because of flex options and the depth of the options market, particularly options on ETFs. So you can get exposure with a lot of things in ETFs. You can write options on those ETFs, if it’s a gold ETF, potentially you could have a gold defined outcome ETF on the gold ETF.
Jeff Malec 49:18
And then I’ll ask you both for your AI takes with my lens of it, right? I got a deck that was trying to get me invest in an AI fund. It was basically the pitch was, it’s going to save 5 trillion of US labor costs, right? And that’s these, their multiples right now are based on saving 5 trillion in labor costs. So to me, if you take 5 trillion out of the US market, consumer spending, that’s a really, really big problem, and if they don’t succeed at that, then their valuations are too high. They get cut in half or worse. So where do you stand on AI with that lens, like, does it hurt future productivity and earnings, or is it overvalued, or none of the above?
Lorne Johnson 49:57
So I guess I would go as far as saying it is a trend. Its formative technology and historical parallels, I believe, are there in what we saw with railroads at the end of the 19th century, radio and more recently, what we saw with the tech bubble, or as others have it was more of an internet delivery bubble, because really what it was, where the investment was, is in fiber optics and things like that. And we know in all of those episodes, there was there was Fallout, right? There was a lot of euphoria in the market, and there were losers. So there were places you could have put your money and gotten absolutely wiped out, but there were enduring investments in things that were truly transformative, and there were beneficiaries from that longer run. AI is a little different than maybe the tech bubble, because some of the highest flyers in the tech bubble actually didn’t have earnings to support the stock prices moving higher, at least as far as your biggest players, your Nvidia’s, etc, I won’t get into the VC funded startups and things like that that are that are on the AI bandwagon, and how any one of those is, is going to work out? You know, there is a story there. There’s actually massive investing going on in data centers. There’s beneficiaries to that. Will we need all that capacity in those data centers? I don’t have an answer for that, but I would venture at least that this is going to have impact going forward, and whether it’s 5 trillion in save labor productivity or maybe better decision making, or better health care, that diseases can be identified earlier. I mean, there’s going to be benefits from all this investment. Who the winners and losers are going to be that’s hard. So I would predict there’ll be some fallout there. But I don’t think it’s a bust as far as we’re investing in something that’s going to be enduring and important
Devang Gambhirwala 51:50
bank anything. I’m just going to say this, we’re in the early innings. It’s hard to make any, any, you know, from my seat, you know, predictions about the future. It’s obviously there’s a lot of potential for all aspects of our lives. And, yeah, whether it’s, you know, over investment today, or is it going to pay off that? That’s hard to say. Again, Lauren touched on the important points. So these are not things that you know, big firms are in. Most of the firms in, you know, in the US and overseas they are engaging in, AI in some way, shape and form, because obviously it speaks to the kind of productivity that that can be gained from that. But again, who knows, winners, losers, what new industries come into play, things like that as a lot of we are in early innings, so a lot, lot, lot to come. But it’s exciting.
Jeff Malec 52:38
I want one of you to say, yes, the human race is Doom, yeah. But to me, it’s like the difference between all those other technology innovations was, this is replacing the human brain, right? So there’s an it feels more of an issue there, and maybe I’m just getting old and cranky, but it feels more of an issue of like we’re this is, this is different this time, because you’re actually trying to replace the worker there, instead of just a new technology, replacing a worker, because they were in the buggy whip factoring, right? This is actually in every industry, try and replace the worker.
Devang Gambhirwala 53:08
You know, it is disruptive. No question about that can be more so I’m not so sure about, kind of not having, you know, being as impactful on the, you know, kind of in terms of how employment and, you know, kind of make humans obsolete. I mean, I’m not quite there yet. I think
Jeff Malec 53:27
not all of them, just a third of them, which would crush the economy. Yeah, yeah.
Devang Gambhirwala 53:31
No, yeah. Again, if history is any guide, we’d always thought that, yeah, like, all of us will be unemployed. You know, machines and robots will run the world. And we know that’s that hasn’t been the case through the last couple of centuries of the Industrial Revolution, to the information revolution and on. We think that that’s on the precipice of something like that, really kind of earth shattering. You know, we’ve, I guess, the human mind is unlimited. And you know, intelligence cannot be, cannot be replicated, and, you know, needs to be involved in whatever technology has kind of come come to play at a given time.
Lorne Johnson 54:07
Yeah, I think, like all these technological innovations that Devon mentioned, there’s big displacement, and there’s concerns that I’m going to lose my job, and the there’s not going to be anything else to do that. The reality is, we’ve got pretty full employment here in the US. People will be doing different things. I think there’ll be an adjustment. There will be some people that, yeah, whatever function they were doing, that job is going to go away. But I do believe there’ll be other ways to take advantage of the technology that creates new jobs. It’ll be like Star Trek. There’s no hunger, there’s no sickness, there’s no money. We just ask the computer. It replicates things. All right. Guys, any last thoughts, I think we’ll leave it there. This has been fun. No, it’s a great conversation. Thank you. We enjoyed it absolutely.
Jeff Malec 54:53
It’s great to be here. All right, guys, we’ll talk to you soon. We’ll look you up next time we’re in New York or do the same in Chicago. Thank. Again, guys, we’ll talk soon. Thanks. That’s it for the pod. Thanks to Devang and Lauren. Thanks to Jeff burger for producing. We’ll see you next week. We got a good one. I finally get to talk about uranium on my own pod, which I’ve been trying to talk about for a couple years now. So good one on uranium. Check it out next week. Peace
This transcript was compiled automatically via Otter.AI and as such may include typos and errors the artificial intelligence did not pick up correctly.
