Building a Macro Investment Edge with Andy Constan

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Intro: 00:01 Nalu FM Finance Podcast. Insights into the financial markets.

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Andy Constan: 00:11 Whether it's a rainy day today or a sunny day or whatever, it doesn't really matter as an investor. What you expect is that over time, there's going to be more sunny days than rainy days.

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Stefan Wagner: 00:48 I'm very excited. I have today, Andy Constan, CEO and CIO of Damped Spring on my podcast. Thank you, Andy, for joining me.

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Andy Constan: 00:55 Well, thanks for having me, Stefan.

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Stefan Wagner: 00:57 Let's start with the obvious one here a little bit. What inspired you to create Damped Spring? And how is it a little bit since you started has evolved?

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Andy Constan: 01:07 Yeah, so after many years working with you and working with others, I finally decided that I wanted to understand macro. So I ended up, thankfully, going to what I think is the best place in the world to learn macro, and that's Bridgewater Associates. And so I worked with them for a number of years. They're highly systematic, which fit well with my background, and yet also taught me everything I could ever imagine about macro. At the same time, it wasn't perfect for me, so I ended up going to Brevin Howard. The partners there come from much more of a similar background than I do, and their hedge fund is a macro hedge fund that runs in a completely discretionary way. 

And so after four years there, their firm had shrunk for a variety of reasons. It's now doing fantastically well. but their firm had shrunk and I was there to, uh, systemize some of their macro thinking and also to provide them with some strategy that was more built around flows than economics. They couldn't afford that anymore. So they decided to launch my business for me, which essentially was a um a macro strategy and research firm and still is a macro strategy and research firm in which I've put to work all of my prior experiences both in hedge fund trading sell side equity derivatives relative value along with all the macro I've acquired over the last.

Now it's going on 15 years and The goal was to expand my client base with institutional firms that were interested in macro. And that's gone great. You know, I'm being read by the biggest macro firms in the world, many of the pod shops and federal reserve and treasury, uh, staff. 

And that's really what has caused the growth. Along with sharing my research thoughts online on Twitter, I've gone from a hundred subscribers four years ago to 145,000 now. And because most of the world is on Twitter, my, uh, institutional business has five X without any cold calling, just people find me and they want to do establish an institutional business with me. And I thought. Maybe I would also begin to offer that to a small group of people who were interested in meeting me on their own personal learning curve and accelerating their knowledge about macro as quickly as possible. And so I have a client base that I would call retail. 

And I'll mention lastly, one of my colleagues who also happened to have overlapped at Solomon, though I didn't know him, but one of these people I've met on the internet, on Twitter, and I, um, started a company called two gray beards and the goal of that business And we decided to offer one short video a week that just says what happened in markets and the economy last week, what should one look forward to next week, and how does one think about the issues that their portfolio has given that context and that framing and hope that you can have much better conversations with your financial advisor. 

Where did actually the name come from, Damped Spring? I think of the markets, and in particular the volatility markets, as being like a damp spring. And what a damp spring is, you mentioned cars, if you have a system that gets hit by a bump in the road, you need a spring because that bump is very high energy and can really, if without a spring, you could be knocked completely off the road. 

But once you have a spring, you introduce and we all have played with slinkies or looked at springs before they keep springing. They keep bouncing down the road. And so when I think about markets, I think about, um, any sort of stimulus being the bump, the market, whether it's a very thin and a liquid market or a very deep and liquid market being sort of the weight of the car. So the sensitivity to that bump. And then the spring is really the market itself, the market's ability to absorb. 

And it's not constant. There are periods of time in which market participants are on edge. And so a bump in the road can create an extremely springy reaction. And then there are what I would call dampers and dampers are by and large things like policymakers who tend to lean against the bumps in the road, but also as something as simple as a bank's ability to lend to new buyers or a market mechanism like a circuit breaker. And so that's how I model the propagation of the wave of information hitting markets. And I named the company after it.

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Stefan Wagner: 06:44 Makes absolute sense. I mean, you're already touching on a little bit, but I want to go a little bit more into sort of what your investment philosophy is. And let's start with something very basic, but I always like to ask these people. Is there any difference between betting and investing? And if yes, what is it for you?

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Andy Constan: 07:00 Well, I think of betting as a very active thing in which, you know, we don't, every day we make choices and choices are essentially bets. We may choose, today would be a good example, choose to walk out without a rain jacket on and find it rains. And so to address that particular action, we may become informed about the potential for rain. And make a choice. And that choice doesn't necessarily pay off. We may be carrying our umbrella around or our raincoat around with the sun shining, or we may be in a downpour without a raincoat. And that's a bet. It has all the characteristics of a bet, including positive and negative consequences, um, and probability. 

Now investing has all those aspects too, but I consider investing to be something that you do, um, for the very long term. Whether it's a rainy day today or a sunny day or whatever, doesn't really matter as an investor. What you expect is that over time, there's going to be more sunny days than rainy days. And there's a very good reason for you to believe that. And so it pays to be invested and accept the consequences as they come. I do think that trading is much more akin to gambling.

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Stefan Wagner: 08:37 Yeah. You sort of, you mentioned, obviously you went from a bank, that's where we met basically, to work for funds in a sense. And what sort of was the difference basically for market making for banks versus a portfolio manager for funds? How did you experience that?

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Andy Constan: 08:53 Yeah, I think the first thing where people make mistakes is on the buy side is they over trade. They may miss the stimulus that we had as salesmen. I was a trader and a prop trader, as were you. We make trading decisions, but we also have market making responsibility. And so what was important to us was business, lots of business. And so a good day was when we were busy. Um, on the bright side, a good day is when you are not busy. A busy day means you are paying transaction costs and that's a killer as a buy side investor. So I think that is the biggest takeaway.

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Stefan Wagner: 09:38 Yeah, I always found that sort of a little bit, we had the advantage of being on the sell side that we made enough money to finance sort of being at the same time long the market convex, long the convexity in the market if it, if it paid out for us while sure as a fund you, you have to face the bid offer spread usually and you're basically already, the first trade you're already down on your mark to market basically. 

Now something actually how you look at risk in your strategy in your own portfolio but also for other people particularly as you also still use convex investment options or other derivatives. How do you sort of measure your risk and how much are you also willing to allocate to such an instrument in your strategy?

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Andy Constan: 10:27 Right. So let me tell you what I do and what I, how I think, and that is that I think the most important thing is for you to be allocated to beta and not touch it. Now there's tweaks we could talk about, but those are much less important than being allocated and staying invested because over the long-term, a diversified portfolio that can manage through all sorts of different environments, earns a risk premium that delivers returns in excess of cash. And so it pays to be invested. So that's what I start with. 

And then what I think once you have that basic framework, the question is, can you make money timing markets? First, my expectation is that very few people can. And so you can really end the conversation there. Um, I just keep trying. I keep banging my head against the wall, trying to generate alpha and I've had an okay, you know, career in doing that, but it requires me to constantly evolve and improve. I think I'm delivering some returns that are number one, not correlated to my beta returns. 

So they're a diversifier and thus de-risk my aggregate portfolio. And so what do I specifically do? I take my beta portfolio, which has a sort of targeted risk. Which depends only on me. It happens to be pretty conservative, but whatever. Um, I try to earn 10% a year in excess of cash on my beta portfolio. And most of the time, that's what it delivers. Sometimes they're drawdowns. Um, and that's one bucket of risk. The other bucket of risk I take, I'm willing to lose all of that 10% in an alpha portfolio. if everything goes wrong all at once.

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Stefan Wagner: 12:40 I presume a lot has to do with macroeconomics and central bank policies and or geopolitical risks. How do you sort of look at that one?

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Andy Constan: 12:50 Yeah, you know, I came from an equity background and sort of understand where single stock, how single stocks work pretty darn well. But even back then, it was surprising to me how picked over and how focused on single name active managing is in this industry, a million people are trying to determine individual stock prices. And so I just can't compete. So where I do compete is where I think the playing field is a little smaller. It's still high, as I said, it's still really hard, but in which I think I have some insight about how the market works relative to others. And that's the macro environment.

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Stefan Wagner: 13:39 Now, is there maybe a sort of call it a war story or one of the worst investments that you ever took and what did you learn from it?

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Andy Constan: 13:50 Well, I think that's an easy one. And this is, it brings back the macro. 1994 was my worst year career to date. Um, and in 1994, I ran a convertible bond desk at Solomon brothers and, um, convertibles started getting cheaper and they just continued to cheapen and cheapen and cheapen. And as a convertible bond arm and market maker, I was, um, long convertible bonds and hedging them and so as they cheapened i took losses my team took losses all of our positions continued to lose money and i think we broke even for the year which means we pissed away all of the bid offer spread that we had collected for in that department that year, which upsets the salesman, upsets management, et cetera. But our inventory just got cheaper. 

And I didn't really understand why. Equity volatility remained high. Credit spreads weren't moving around a lot. But what I had missed was the impact of the surprise tightening by the Federal Reserve. and the subsequent unwind of first mortgage arbitrage firms and then places as odd as the Orange County Pension Fund that had extreme leverage bets on interest rates. And interest rates had changed surprisingly and fairly meaningfully. Um, and so what I learned from that, and that really helped in periods of time, like 97, 98, um, 2001, 2004, 2008, and 2020 was. You need to know when the world is deleveraging because everybody gets a margin call.

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Stefan Wagner: 15:54 Yeah, I do remember 1994 because that was just quite early in my career, but I was at Bankers Trust and we had these range accrual trades on the difference between 10-year swap rates and three months LIBOR, which blew out completely out of the range. Obviously, never had a chance to come back and huge un-leveraging happened there. But there was like, you mentioned Oral County, but also a lot of other corporate

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Andy Constan: 16:21 Counterpart is not really a they suddenly claimed all the professionals would understand what yeah, I mean Robert Citron who was the treasurer of orange county was probably the poster child for buying a bunch of things sold to him by wall street that he didn't understand.

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Stefan Wagner: 16:38 Now you have done this a long time and you're doing it, you must have sort of found a way to structure your process and surroundings to be efficient. You know, is that, is that something you could share with people, what you find, what works for you?

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Andy Constan: 16:54 Well, I guess the first thing is, um, shiny object avoidance. Um, try not to be gravitated to the next new thing. Um, and try not to be distracted by that, the noise around the next new thing. Um, a corollary to that is stay in your lane, which is know what you know, and have questions about what you know, but. create barriers to trying new things that can, uh, that may be appealing for whatever reason, but may cause you to lose track of what you're good at and, um, enter an area where you're not good. 

And I guess the last thing that that all suggests is that you just be narrow. And the answer to that is no. There are things that happen that appear to be shiny objects, but actually are meaningful. Like the, like the period of time that I just talked about in 94, it's not like we didn't see it. It's not like we didn't see all this, you know, this stuff going on. We didn't relate to whether it was important. for us. And so things happen, and you have to be determining whether what is happening is worth ignoring or absolutely must not be ignored.

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Stefan Wagner: 18:27 Thank you. Now there's sort of three little questions I always like to ask. That's a little for you personally. So what drives you, you know, I think you also have a passion for food, for example. I think in your LinkedIn profile the background is a sandwich or something.

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Andy Constan: 18:43 Yeah, what drives me? I guess the first thing I would say is it certainly isn't the money. Every day I come in feeling the same challenge that I did when I started my career. I wake up at five in the morning and I'm immediately reviewing markets and all that stuff. And so it certainly must be a basic passion, an urge. And I'm just super curious and want to know the answer. And I'm driven to know answers. 

And when you know answers, the best thing to do is have questions. And then once you have questions to know what questions are worth exploring and then to go and explore them. And like every day, that's sort of what drives me. And the same thing applies to my hobbies, whether it's, um, skateboarding or wakeboarding or cooking. I happen to like those things and I want to be, uh, and every day I want to get better at them.

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Stefan Wagner: 19:47 So then the next question for you is that actually what is actually your definition of success?

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Andy Constan: 19:53 That's a tough question. It's so personal. I guess what I would say the most thing is lead a rewarding life to you and your family, be valuable to your family and your friends and have a rewarding experience that you know in which you enjoy what you do. I've been blessed with loving what I do and it being rewarding to me both financially and personally. So, you know, I just consider that a blessing and to be honest, mostly fell into what I've experienced and just worked hard in the places I've landed.

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Stefan Wagner: 20:28 And the less, less, less heavy questions is what is on the top of your current music playlist?

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Andy Constan: 20:35 This is a very sad story. I'm 60 years old and my grandmother wore hearing aids. My father wore hearing aids and now I wear hearing aids. There was a period of time in which I never was without music and. I still wish I could hear as well as I do. And I had a beautiful collection of vinyl. I still have that. Um, I had a top of the line, um, audio file stereo system with vinyl records and all the right speakers and all that. And it just doesn't have the impact for me, but top of my list is always Led Zeppelin, Grateful Dead and Pink Floyd.

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Stefan Wagner: 21:23 Oh, excellent choices. And in vinyl, even better. So if people want to like what they heard today, and they would like to get in contact with you, what's the best way to reach you?

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Andy Constan: 21:33 Yeah, I mean, dampedspring.com, at dampedspring on Twitter, or twograybeards.com are the best ways.

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Stefan Wagner: 21:42 Excellent. Thank you, Andy.

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Andy Constan: 21:44 It was a pleasure. Great to see you again.

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