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In this episode of The Signal, Marc Rubinstein discusses what he has learned during his 25 years investing in financial markets, how the 2007-08 financial crisis was a turning point in his career, and today’s “regime shift”.

Episode Transcript

Catherine: [00:00:06] Welcome to The Signal, a podcast presented to you by Third Bridge, the world’s leading independent research provider, exploring how some of the globe’s most investable industries are facing upheaval. My name is Catherine Ford, and I’m a journalist with a 20 year track record of reporting on a wide range of financial topics such as capital markets developments and M&A. Joining me today is Marc Rubenstein, author of the influential newsletter Net Interest, exploring financial sector themes. Mark will be giving his insight into his career to date, his investment philosophy, his take on the markets today and what he sees on the horizon. Hi, Mark, I’m delighted to have the opportunity to chat to you today. Let’s get stuck in. Can you introduce yourself to the audience giving them a bit of an insight into your career path and how you got to where you are today?

Marc: [00:00:53] Well, thanks for having me, Catherine. My name as you’ve introduced is Marc Rubenstein. I have 25 years experience in and around financial markets. I spent ten years as a partner in a hedge fund, one of the oldest hedge funds in London, where with a team of colleagues, we looked exclusively at the financial services industry, investing in banks, insurance companies, asset management companies on the long side and the short side, in and around the great financial crisis 2007/2008. Fund was actually launched in 2004. We wounded up ultimately in 2016. Prior to that, I’d spent some time working for a number of different investment banks as an equity research analyst focused on the banks sector and the segue into the hedge fund was through a well, the fund was a client on the sell side. I had a number of institutional clients, would recommend stocks to them and then sometime in around 2006 decided rather than making those recommendations, it would be fun to actually do the investing myself. And that’s when that switch occurred.

Catherine: [00:02:16] So it’s quite an interesting journey. So you’ve looked at the financial sector from all sorts of different lenses. What’s one of the sort of messages, one of the observations that you’ve made throughout that process?

Marc: [00:02:28] It’s a really fascinating sector. At the time, prior to the financial crisis and I talk about the financial crisis because in my career it was a very, very big moment. But I’m aware that it was now 15 years ago and that although it’s still prominent in any kind of financial history, fewer and fewer participants in global markets have first-hand experience of that financial crisis. But it was a turning point in the industry. Prior to that, the financial sector made up a very material part of the overall stock market. So being a financials analyst meant that one was looking at probably the preeminent sector across all the market. And one that not only had economic significance because the financial sector really kind of set to the heart of the economy, but had a valuation that, going into the financial crisis, that belied its kind of significance, its importance. That changed. And right now, the financial sector is a much smaller part of the overall market. And so what that’s taught me is kind of just the importance of cycles, that  there’s a transience to market sentiment that markets shift. They operate in waves in cycles fundamentally, and that sometimes those cycles are overlaid. And the financial cycle is a specific cycle that overlays on top of the broader financial market cycle.

Catherine: [00:04:14] We’re going to spend some time talking about misconceptions, and I’d like to come back to this theme that you brought up of cycles. And there are cycles that we go through. And it’s fair to say there’s so many participants in the market now that are simply too young to have experienced these cycles that you talked about. What I would like to hear from you, though, do you think it’s going to ever go back to that? Are we ever going to see this dominance of the financial sector in the overall economy? Or do you think we’ve actually leveled out now? And we’re at a stage where it does actually reflect what we’re seeing in general?

Marc: [00:04:41] It’s a really interesting question. One of the themes of the of the day, one of the key themes of 2022 is that globalization may have peaked, that we’re in an era now of deglobalization. Again a cycle. Prior to the First World War, prior to the 1920s, we saw a big increase in globalization, and that receded. And then post the 1970s, we saw another increase in globalization, which peaked several years ago and now looks like it’s receding. Financialization is another kind of macro trend that may have also peaked for many of the same reasons that globalization has peaked. Having said that, you know, another feature, you know, we can go on and explore many of these details later. But one of the key features of the financial industry is that it is highly regulated. There’s a number of reasons why that is the case, but it’s a very highly regulated industry. In any regulated industry, there will always be the incentive from players in a competitive, market-oriented environment to find ways around that regulation. And what we’ve seen recently is, I call it regulatory arbitrage, that many participants in the financial industry, they’re not technically banks, but they kind of operate a lot of fintech, a lot of financial technology companies do this.

Marc: [00:06:09] They operate kind of between the cracks of regulation. And that’s always been the case in financial services. And if you include, you know, I’ll put some colour around this. So Apple is a technology company, one of the biggest technology companies, one of the biggest companies in the world, announced quite recently that they want to go into the lending business, but they want to offer a product which allows customers to pay later and that they will retain those receivables on their own balance sheet. It’s not a surprise that they’re going into that market because it’s adjacent to the core commerce business that they’ve participated in for a long time and the payments business that they’ve participated in more recently. What’s a surprise is that they’re keeping these receivables on their own balance sheet and not using a banking partner. It’s not regulated as a bank. And so are we going to go back to the banking sector having a disproportionate share of the overall stock market? Probably not. But will banking, broadly defined, whether it appears inside a bank, inside a technology company or inside a fintech be a disproportionate share of global revenue, global commerce, however you want to factor it, global GDP? Possibly. Possibly, yes.

Catherine: [00:07:29] Okay. Now we want to give our listeners the opportunity to get to know you a little bit more as a person. When I was doing my research, I read obviously that you’ve done some early stage investments into two sectors yourself into both consumer and the fintech space. Talk to us about what attracted you to those two particular spaces?

Marc: [00:07:46] Yeah, it’s really fintech, actually. And that’s where I spend more of my time now. And the rationale there was my background as a financial analyst, having built up experience looking at financial companies and then observing what was available through technology in the financial sector that it gave me, that was a strength, if you like, that I was able to bring. And the observation that I had was many technology people were going into one of the criticisms of fintech, one of the criticisms to come technology, entrepreneurship generally, is that a lot of it comes out of Silicon Valley with a Silicon Valley mindset. Influenced by what is observable in Silicon Valley. And so it occurred to me, having looked at finance globally and as a professional investor, I invested in financial companies in India, in China, in Brazil, Europe, the US, globally. One of the interesting features of financial services markets is that they’re all different and that they develop differently, partly because of regulation, which we’ve touched upon, but partly because of culture as well. And that Silicon Valley mindset I kind of tech first mindset wouldn’t necessarily embrace those nuances around regulation, those nuances around financial services history, that there is a path dependent here. There’s a reason why things are done in the most efficient way in every market in the world. As I say, some of it is regulation, some of it is path dependent, some of it is culture. And that that kind of historical knowledge of the way finance works and that first hand experience investing with a finance first perspective was able to give me some value add when looking at financial technology.

Catherine: [00:09:43] Sticking with the theme of sort of getting to know you, you’ve spoken about your very varied career. What does your job today involve on a day to day basis? Who do you work with? How big is your team? Talk us through your workflow?

Marc: [00:09:55] Well, right now, what I enjoy most is writing. As any writers who are listening will know that can be a solitary pursuit. I will speak, I’ve built up a network, having spent 25 years in financial markets, with market participants, many of whom I’m still in touch with, and I will speak to them in order to understand what’s going on at the coalface in financial markets. One of the great things about writing, so I launched this newsletter, Net Interest back in 2020. It was kind of a pandemic baby, if you like, May of 2020 and was surprised with the degree to which its grown, now at 35,000. People read it every week and that has fueled and compounded the network. So now chances are, whatever I write about, and so once a week I’ll write something with a financial flavor to it, and that can be markets, it can be financial history, it can be payments, it can be consumer banking, investment banking, financial technology, investment management, that there’ll be someone amongst those 35,000 that knows more than I do about whatever that theme and writing is. But the great thing is, you know, I think I’m humble enough, I’m not giving a definitive account. I’m very, very keen to garner feedback and that the network has grown by putting that newsletter out. And kind of I think people have used the word flywheel when looking at business strategy, but there is a kind of a bit of a flywheel there. I put stuff out. It grows. The network feedback comes in and off it goes and it’s great.

Catherine: [00:11:45] Looking back over all the different hats that you’ve worn during your career, was there a time that you really felt that your work-life tested you? Any sort of regrets, anything where in hindsight you think I could have done that differently?

Marc: [00:11:57] I mean, the investment business is full of such examples. What’s different about it compared with other jobs, if you like, is that there’s a metric, there’s a real time metric. Every decision is evaluated in real time. Now time scales will vary. There are some investment strategies which are very, very short term. And that feedback can be immediate. Most investment strategies, the feedback is not immediate, which makes it for a difficult job actually, because you can do the best research in the world and not have a positive outcome. You can do very little research and invest on a hunch, and it’s not replicable. It won’t work over the long term. It’s not a good process. But on an ad hoc basis, it can work in a kind of randomized way. You know, we’re talking in the investment business about good, bad, cheap, dear. It’s quite easy, actually, to find a good company, whether it’s a cheap company and therefore a good investment prospect is a whole different set of criteria. And so, you know, I mean, without going into specific examples I made, you know, I’ve made over my career hundreds if not, probably not thousands, because we were quite focused, ran a relatively concentrated portfolio with quite a low degree of turnover. So probably hundreds, maybe low thousands of investment decisions. You know, the hit rate actually was and this would be true for most investors, the hit rate, maybe surprisingly, to listeners that are not investors, the hit rate is not that high actually. The hit rate might be over 50%, but no higher than 55%. Yeah, but the key was in sizing the hits, which is about conviction. And then to come back to your question, monitoring the success of those decisions. So yeah, you know, without talking about specific examples all through my career, it was a real time monitoring of decision making.

Catherine: [00:14:01] But the point that you made about conviction, I mean, that’s something relatively easy to say for someone who’s got lots of experience. So, you know, for younger listeners who are thinking about going into a career or who generally, you know, people who want to go into building a career in investment, what sort of the advice that you would give them? Because obviously time is not something that you can give them, that’s just something as time goes by, you develop more experience. But at the outset, what’s your advice to them?

Marc: [00:14:26] A lot of absorption, a lot of reading. People talk about obsessive personalities as being quite good investors.

Catherine: [00:14:34] Is that you?

Marc: [00:14:35] It’s not actually. One of the reasons I gave up managing other people’s money is that I don’t have that. I didn’t sustain that obsessive personality. Curiosity is important. Pattern recognition is important and that is learned. Pattern recognition is a learned skill through experience living in markets, but also through reading and observing what other investors have done and other investment cases from the past. But it’s a combination of both because there’s the intellectual component, the analytical component which can be gleaned from books, can be gleaned from investment cases, can be gleaned from watching other. But the behavioural component, internalizing what makes a good investment, really understanding that pattern recognition, that can only really be gained through experience. There are algorithms out there. There are multiple investment algorithms. Clearly, passive investing is one such algorithm, but there are others. Passive works as the market shifts, but as market tone, as the market mood, as the market regime shifts. And right now it kind of feels like we’re in one of these market regime shifts. We’ve seen growth outperforming value. We’ve seen low interest rates. We’ve seen a bull market in bonds for 12 years now. We’ve seen globalization. We’ve seen technology being rerated. We’ve seen duration outperform 12 years now. It feels like we’re in a market regime shift right now, and it’s difficult for algorithms to identify those shifts.

Catherine: [00:16:18] You’ve led us quite nicely into sort of the next area of conversation, because I wanted to pick your brain on specifically the financial sector and how you’d characterize the current market conditions. And you spoke about, I think, the theme of globalization or decrease in globalization is one of the themes that you’ve spoken about a couple of times. What are the sort of market conditions are there that you think investors need to be aware of at the moment as they look specifically at the financial services sector?

Marc: [00:16:44] It’s always hard. It’s always, you know, any investor who doesn’t precede any comment about the market, that it’s very hard, kind of isn’t, it’s kind of misguided. It’s always hard. I think right now we’ve got, we’ve got a confluence of multiple events. Interest rates are going up that has massive consequences for financial industry, whose raw material is money. And so if the cost of that money through higher interest rates is going up, that has major repercussions. It’s possible we’re going to be entering into some kind of recession. That has big implications as well. There’s been a lot of excess that has built up in markets and often when rates go up, liquidity by definition goes down. And often that exposes fractures in markets, areas where markets don’t really work, where excess has kind of submerged some of the underlying economics of those market segments. So we’re seeing things break. We’re seeing now in crypto, for example, right now there are other areas of stress that are building up in the system. So these are all areas to look out for in a kind of regime shift like we’re having right now. And financials are really very exposed to them.

Catherine: [00:18:00] And how do you think the conditions that we’re seeing in the financial sector compared to what we’re seeing globally? I mean, some of the point that you made about the interest rates and the looming recession, that’s obviously something that we see across all sectors and is going to affect all sectors in the future as well. How exposed and how immune is the financial services sector to these challenges?

Marc: [00:18:19] The difference with the kind of lending-based business and a classical commercial business is that the cost of doing that loan doesn’t appear until after the fact. And if the market environment changes and we enter a more recessionary environment, the cost of loans that were conceived in a more benign environment and priced in a more benign environment will appear and make that business fundamentally unprofitable. So any kind of lending business is exposed. So that’s a large part of financial services.

Catherine: [00:18:50] Should we be concerned about the state of any banks?

Marc: [00:18:53] No, it’s an interesting question. I think not, actually. I think one of the features of the regulatory environment that was imposed following the financial crisis of 2007/2008, was to create more resilience around banks. But coming back to one thing I was saying earlier is that lots of financial companies, broadly defined, have found cracks in the regulatory framework. And crypto is a great example of that. And that’s maybe one area where we should be concerned. The good thing for the market more broadly about crypto is that it is isolated, there weren’t that many bridges. One of the questions that in the bull market was made of crypto was precisely that there were no bridges into the real world and that was seen as a drawback of its adoption. The fact that there were so few bridges between crypto and the real world is a benefit in the sense because any issues there can be isolated and there won’t be contagion. There is a firebreak between crypto and the broader economy and broader financial markets. The banks themselves, I think, are resilient. Actually, just recently the Federal Reserve did an annual stress test of its regulated banks, which was introduced in the aftermath of the financial crisis. Actually, the introduction of that stress test marked the bottom of the financial crisis. It kind of modelled the trough back at the beginning of 2009, and all the banks, the regulated banks passed, they’ve all got enough capital to absorb quite a severe downturn, actually. So I think they’ll be fine. You know, one of the features of financial crises through the ages is that they rhyme, but because the general fights the last battle, the regulator very, very cognizant of all the causes of the 2007/2008 financial crisis, highly, highly unlikely such a similar event is going to happen again, but a slightly different event will happen again where activity has permeated those cracks.

Catherine: [00:21:40] Marc, earlier on in the conversation, you spoke about the cycles in the market and how there are some misconceptions around that. Do you fundamentally feel that the space is well understood or are there sort of broader, widespread misconceptions about the space and how it’s organized?

Marc: [00:21:56] I think there are huge misconceptions. I was talking before about the kind of Silicon Valley mindset and it’s a great mindset. It’s a great mindset. And it has brought huge amounts of value to multiple industries, not least the finance industry. But financial services do work different. There’s a kind of culture in non-financial services tech to focus on growth almost at all costs and revenue growth and therefore, price to sales metrics were seen as a good way to evaluate companies outside of financial services. In finance, growth is really very easy to generate. A lending company is giving away money, and the question is the price of which they give away that money, but not difficult for financial services companies to grow its customers to grow its revenues, actually. But the challenge is when the market shifts, getting that money back. I’m talking about lending company and those cycles and actually the correlation of all those cycles, the fact that that cycle kind of tracks the broader, there’s a classical kind of cycle of euphoria, but credit tracks that and funding tracks that as well. Companies, finance companies, if they’re not raising deposits, they need to raise money at price X to lend at a price Y and kind of take out some kind of margin. And often what happens when the market suffers a downturn is that the suppliers of funding at price X, they disappear as well. So you have kind of multiple cycles that are imposed on each other. And when the market turns off on all those cycles, that’s where the contagion hits and all those cycles turn down at the same time.

Catherine: [00:23:44] You spoke about crypto. We’ve spoken about fintech. What are sort of the hottest asset classes, the hottest subsectors when it comes to the financial services industry?

Marc: [00:23:54] The thing is, right now, things are things are cooling off. Things are going cold. Right now we’re in, we’ve seen, the first half of 2022 was a record period for market growth, the wealth drawdown, the combination of bond markets selling off and equity markets selling off. Crypto isn’t a major asset class in the grand scheme of asset classes, but sell off there as well, it’s kind of a microcosm for risk appetite. Things are cooling off. Inversely, you go back to the year 2000 and look at those companies that were able to survive a tech crunch that happened then in that period of 2001/2002 came out of it very strongly. Amazon is the prime poster child example, came out of it very strongly. But there were other financial companies as well. PayPal came out of that period very strongly, having raised sufficient capital going into it. So some of these companies, it’s an opportunity. There’ll be a shakeout in financial technology companies and those that survive because they raised capital, because they’ve got a proposition that kind of works in any market environment, not just a kind of euphoric, you know, bull market environment.

Marc: [00:25:14] Robinhood is a great example of a company which had its optimal market environment kind of 2021, January 2021. Actually its customer activity peaked in the first quarter of 2021 when retail engagement in the stock market was at a high that we haven’t seen, hadn’t seen since 2000, since 99, since late 99, these kind of generational cycles, arguably, that business model is going to be challenged in an environment where there’s less retail trading activity. But those models which emerge that work in an environment which doesn’t require that sense of euphoria where the company has raised sufficient capital going into it will not only survive, they’ll thrive, particularly as competitors drop out. So it doesn’t really answer the question about the hot asset class because I think everything’s pretty cold right now. You know, we talk as investors about return on capital and return of capital. And I think we’ve flipped from an environment where we’re looking to maximize and optimize return on capital to one where we’re looking to return, return of capital. And capital preservation is really very important in this environment.

Catherine: [00:26:26] Well, given this environment that currently there are so many uncertainties and so much risk with it, I’d like to spend some time talking about the topic of risk, which was also mentioned in your most recent newsletter, where you spoke about the approach that is being taken by David Wildermuth, who’s Credit Suisse’s new Chief Risk Officer. First of all, can you describe to us the stance that he is taking when it comes to risk, why that is unusual given Credit Suisse’s recent past? And then also, I think why it is so noteworthy?

Marc: [00:26:54] Well, it was a broader point really about, you know, I’m fascinated in the investment banking industry. Go back to the nineties. Michael Lewis is a phenomenal writer. He’s written kind of 18 books now. His first was Liar’s Poker about life on the trading floor of Salomon Brothers, as it was then. Recently he’s on the record as saying that he’d find it very difficult to write a book about investment banking today because the characters aren’t as colourful, much more computer driven rather than driven by those sorts of characters who he portrayed very well in Liar’s Poker. It’s an industry that I’ve been fascinated in. It’s very, very colourful industry and has players like Credit Suisse that have their own personalities. And the Credit Suisse personality is one that falls, very sadly, because I spent a large part of my career in Credit Suisse, still have a lot of ex colleagues who work there today, but it just seems to walk into mishap after mishap. And there have been and I wrote about these in my recent newsletter, several of them.

Catherine: [00:28:04] That’s a, that’s a generous way of describing it, a mishap.

Marc: [00:28:07] Yeah, I guess it’s the ex. As I say, I’ve got a soft spot.

Catherine: [00:28:10] The loyalty stays there.

Marc: [00:28:11] The loyalty, precisely the loyalty stays there. So it’s tricky. Yeah. And kind of the question came to me why these, you know, what is it about Credit Suisse and it’s really it’s very difficult for a financial analyst to really get to the heart of this, even for a strategy analyst. But there is something about the culture of these firms that is sustained as and when, you know, the people, the there’s a great comedy sketch that British listeners will be familiar with from Only Fools and Horses where Trigger talks about, he’s a road sweeper. And he talks about having had the same broom for his entire career. And he says he’s changed the head, he’s changed the stick many, many times. But it’s the same broom, actually. It’s an old Greek fable. Credit Suisse has changed. it’s changed the head, it’s changed the staff, it’s changed the co heads, employees have changed. But this culture seems to persist. And these investment banks have culture. And and it’s a very difficult thing to overcome, particularly when the day to day is shifting so rapidly, particularly when there are fires to fight as volatility emerges in markets, very difficult to overcome a culture. At the other end of the scale, there’s a firm. I mean, Goldman Sachs. I mean, similarly, no firm is immune. Goldman Sachs suffered a number of mishaps as well. But the culture there is quite, quite different. And these companies have cultures which kind of fascinates me, I guess. I guess to conclude here, you know, culture is a huge part and it’s true in investment firms as well, culture is a huge part of risk management. You know, we can look at risk through models. We can have a dashboard that looks at risk. We can have a chief risk officer that kind of looks at those dashboards. But fundamentally, risk is a culture and ascertaining that culture is not as easy as simply looking at dashboards.

Catherine: [00:30:07] One of the things that we quite like to do on our podcast is put our speakers on the spot and ask them for a one to watch. So in your sector of expertise, is there one subsector, one company, one market, one opportunity that you think that’s actually that’s the one to watch? That’s where I need to keep my eye on in the future.

Marc: [00:30:30] So I’m really interested in payments mechanisms in some emerging markets. One of the advantages of crypto as articulated by crypto enthusiasts, is the ability to make quick payments. And I think that argument, frictionless, cheap payments, that argument is steeped, I think in a US experience where the payment system for various reasons linked to the federal nature of the country, linked to historic regulations, linked to incentive structures, it’s not the most sophisticated, in fact, it’s one of the least sophisticated payments mechanisms globally. You know, signing cheques, for example, now just doesn’t happen in many countries like Sweden. Paying with a mobile phone now happens in many, many countries at greater penetration than in the US. When people talk about crypto as being a great way to pay quickly, frictionless, cheaply, what’s happening right now in Brazil in particular, and in India through state sponsored schemes known as PIX in Brazil and UPI in India: absolutely cutting edge, really phenomenal. And that coming together of the private sector and the public sector through the state to create an infrastructure, a paym ents infrastructure which allows easy access so therefore brings in the unbanked and underbanked increasingly might allow cross-border payments cheaply, frictionless, easily, is phenomenal. And the growth of those protocols in those markets and the extent to which they might be replicated elsewhere in the world, that’s definitely something worth looking at.

Catherine: [00:32:13] Very, very interesting and lovely that you’ve mentioned those two sort of areas, crypto and card payment systems, because that links very nicely to two podcasts that we recently recorded on exactly those two topics. So thank you very much for that, Mark. Let’s now cast our eye to the future. What is the direction of travel for the financial services industry? Where do you see it developing? What do you see it looking like in the next 5 to 10 years?

Marc: [00:32:38] Yeah. So as I mentioned, we’re going through this regime shift. I think the banks will come out quite well. I think it takes a generation of unlearning when, to almost rip up the old playbook. So I think the 2007 2008 playbook will not work this time around. The banks are fundamentally more resilient. They will suffer an earnings recession. Actually, higher rates may absorb some of the downside from that, so it might not even be that severe. They’ve been crushed over the past ten years from lower rates, which hurt their ability to generate a spread on their deposit businesses. So banks I think will come off quite well. And yeah, that’s one that’s just one area that definitely I think is worth keeping an eye on.

Catherine: [00:33:28] Let’s wrap up by asking what motivates you day to day? What gets you up in the morning and gets you going to work?

Marc: [00:33:34] Well, it is curiosity. I mentioned before curiosity. And, you know, people have asked, people ask me today for the kind of single skill in order to identify a good investor or an analyst. And I would say it is curiosity. And so to come back to your question, you know, what I love about the newsletter writing is picking each week a theme related to financial services. Sometimes I’m kind of drawing on my own experience and it flies right out of me. Other times I’m answering a question which requires some quite deep research, requires digging down some rabbit holes. That’s where I’m happiest I think, the curiosity that comes from delving into one of those rabbit holes and seeing what comes out.

Catherine: [00:34:29] Mark, thank you so much for sharing your experiences and insights. Unfortunately, that’s all that we have time for today. I’d like to thank you all for listening to this episode of The Signal presented to you by Third Bridge, the world’s leading independent research provider. Join us in a fortnight for the next episode. And in the meantime please rate review and follow our podcasts. Indeed, if you like it, tell a friend. Find us on Spotify, Apple Podcasts and wherever else you get your podcasts from. Plus From me, Catherine Ford, that’s goodbye and until next time.

Key Takeaways

  • Global economic uncertainty and the threat of a recession could trigger a shakeout in financial technology companies
  • After a period of low interest rates and a bull market in bonds, the investment landscape is seemingly in a regime shift
  • For some companies, the harsher economic environment will be an opportunity to emerge stronger

Episode Guests

Marc Rubinstein

Former hedge fund manager