Interview Question Share one Tear one: "If we gave you 10 million..." --

Ok, so here we go, please share one and rip another apart. This is one of the most dreaded question (due to its shear open-ended nature).

"If [insert bank here] gave you $10 million to invest, what would you do with it?"

 

I'll start it off,

We just saw our first dissenting vote on the FOMC committee's report on interest rates. I think that this is a sign that we may, in the near future, start seeing the federal funds rate come up from its current historical lows. With this in mind, I would take a short position in high-yield bonds, which have seen a huge rally in the last year (Thomson Reuters reported that High-Yield Debt offerings were up ~350% on the year) and would be vulnerable to an increase in the federal funds rate.

 
Tasteful Thickness:
I'll start it off,

We just saw our first dissenting vote on the FOMC committee's report on interest rates. I think that this is a sign that we may, in the near future, start seeing the federal funds rate come up from its current historical lows. With this in mind, I would take a short position in high-yield bonds, which have seen a huge rally in the last year (Thomson Reuters reported that High-Yield Debt offerings were up ~350% on the year) and would be vulnerable to an increase in the federal funds rate.

How are you shorting high-yield bonds? I didn't know you could short high-yields.

Why don't you just buy Credit Default Swaps?

-------------------------------------------------- "Whenever I'm about to do something, I think, 'Would an idiot do that?' And if they would, I do NOT do that thing." -Dwight Schrute, "The Office"-
 

think man. credit default swaps are related to credit quality. you could have higher interest rates, which will push down bond prices by construction, but if the firms are still fine, credit quality isnt deteriorating so cds is a bad way to play that.

 
Best Response

you wouldn't be investing any of your money with a short position on those bonds....unless you were buying an ultrashort high yield etf, which i have never heard of...

i would be in sectors that have undeniable secular positives, that wont be super-cyclical, where i can get long-term capital appreciation. 10mil shouldn't be hot money. i would also hold some names (not all) that provide income along the way (dividends are a good in inflationary times).

the idea of global diversification is less valid these days, as financial market integration has led to higher correlation between global indices. that said if you pick distinct, best-of-breed firms in key countries exposed to lightly-correlated trends with good balance sheets and management, you will be better set-up.

this is a market that is dislocated from fundamentals, but if you don't want to trade based on technicals (the question was to invest, not trade) i would be in names that have grown across economic cycles. we can use 10yr eps and rev growth rates for that purpose, and set a lower bound at 10%.

an uncertain market is a better market for large-cap than small, so i would stay away from anything under 10b mktcap. it is partly a liquidity premium as well (large cap positions are generally more liquid), so i would avoid anything trading less than 1m avg vol 1yr.

inflation is a concern, given that the fed has lost control of the monetary base. that is scarier for low-margin businesses than for high, as their margins can more quickly be eroded by inflation. i would set a lower bound on net profit margin at 10%.

nothing will ever make me invest in a firm priced over 20x earnings. i miss out on some opportunities there, but i also have avoided some silly bubbled names.

i'm guessing interest rate uncertainty is going to reintroduce some volatility into the market. i would want to have some exposure to that, but also have some protection, by mixing beta profiles between .5 and 2

strong balance sheets are always a must. i will only pick a firm with D/E > 1 if it's covering interest payments at least 5x with EBIT.

The following 15 names satisfy all the balance sheet, income statement, and market requirements i've laid out (note that my requirements don't vary wildly industry-to-industry. i've intentionally picked metrics that are transferrable). in addition they are well-positioned to benefit from undeniable regional (or global) secular trends. (note that there are other firms that satisfy the quantitative requirements, but that are in areas without discernable drivers.)

FCX, BBD, SYK, AAPL, AMX, DHR, PBR, TRV, CHL, SAP, ZMH, EXC, EBAY, JNJ, RIMM

 

The actual mechanism for shorting high-yield debt is non-trivial. It's also not free. You have to pay for that trasaction (through borrowing the bond from a desk that happens to have it), and since it's high-yield, you're going to be funding yourself at an exorbitant rate. Let's say you can do it--you short a bond. What then? You're exposed specifically to the debt of that one company. That's a pretty risky strategy. What are you going to do with the cash generated from the short-sale of the security in the market? Keep it in USD? Buy equities?

The problem with shorting is that you are never outright short everything. If you are short anything, you are long cash, which means you need to have a plan to do something with that cash. Otherwise, you're short a security that yields, say, 20% per annum, and long a security that yields almost nothing. That's not particularly impressive carry, so you aren't going to want to fund yourself on a daily basis. Instead, you're going to need to secure funding for your short for a few months. Let's say you fund yourself for a month. You're going to have to pay (at least) 20/12% of the notional to make that happen. If it's 10MM USD, you're going to need to pay about 160k to make that happen. That means you need about a 2% movement in the price of high-yield debt (specifically, the bond you are short). There is a good chance, though, that your bond never trades in the market in the next month, and you don't realize and price change. Even if you do, it could go against you, and you could lose a shit-tonne of money.

I could go on, but the point is this: that's not a great answer to that question unless you understand the mechanics of the trade you are going to put on. If I were to drill down on your market knowledge after asking you this question, and you couldn't explain much to me, I'd tell you to play around with stocks like all of the other people in the market that don't know what they're doing. I'm just saying--if I gave you 10MM USD, I wouldn't want you putting it to work that way.

 

CDSs typically do have interest rate exposure on the mark-to-market of the position, but overall, B3 is right. Best to go with INTEREST RATE swaps.

IN ANY CASE, I think taking one-time positions is for chumps. I'd be putting $10 million into a market-making system on some of the less liquid stocks that are easy for a computer to keep track of the fundamentals on.

 

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