Idea Brunch with Ryan Rahinsky of Blue Outlier Capital
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Ryan Rahinsky!
Ryan is currently the chief investment officer of Blue Outlier Capital, a value-focused fund that also invests in long-term options in special situations. Before launching Blue Outlier Capital in October 2022, Ryan traded his own capital, worked as a consulting associate at BDO, served as a non-commissioned officer in the U.S. Navy, and earned an MBA from UNC Chapel Hill in 2021.
Ryan, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Blue Outlier Capital?
Appreciate you having me. I started investing initially when I was 12 years old and have been determined ever since to start a fund. I love the mental competition of markets, and the relatively even playing ground no matter who you are or where you’re from. It’s as close to a perfect meritocracy as you can wish for in a profession, the numbers speak for themselves.
Although I always wanted to start a fund, I come from a long family history of military and police service and wasn't exactly sure about the path to take to accomplish this. I’m from a small town in Tennessee where I enlisted in the Navy at 19 and became a non-commissioned officer quickly thereafter. I balanced active duty and two 6-month deployments with my helicopter squadron to South Korea with going to school full time, and graduated Magna Cum Laude in 2.5 years, 6 months after separating from the Navy.
After graduating I traveled internationally before working in Israel for 7 months at BDO on their U.S.-Israel Desk, working with startups and entrepreneurs in Tel Aviv. Not only did this amazing experience teach me a lot and introduce me to my wife, but it also led to a consulting position with BDO in Washington D.C., which quickly led to me being admitted to UNC Kenan-Flagler for my MBA.
I learned a lot while at UNC and worked on my investment strategy independently outside of school. The perfectly efficient markets I encountered in the classroom conflicted with my experiences and how I knew markets behave. Although I didn’t learn anything pragmatic from a capital markets perspective, I gained a lot of valuable insights into other subjects from my time there, particularly in entrepreneurship and energy, while diving deep into more pragmatic market literature in my own time.
While at UNC I interned at Amazon. This was during the initial phases of Covid and I reached for an internship that had a high salary and job security. However, during my time at Amazon, it became abundantly clear to me that I needed to focus on my passion for markets. I was oftentimes distracted during my internship by focusing too much on the market and my proof-of-concept account.
At this time, I was already seeing impressive results from my strategy and ended 2020 up 317%. This was when I decided to commit to my passion for markets full-time and continued to use my capital to test my strategy. The results continued to compound, and I ended 2021 with even better performance than 2020. At this point, I had now turned my capital earned from my time in the military into a considerable nest egg, and I started getting attention from classmates and accredited investors to manage money on their behalf.
Despite the promising results I didn’t feel confident enough yet and wanted to wait until I proved my strategy through more of the market cycle and into a bear market. Having good performance in 2020 and 2021 wasn’t enough of a track record for me to feel comfortable investing on behalf of my LPs. It was only after the last year I feel I’d finally proven our strategy enough to invest for others. I ended 2022 up over 50%, and over the course of my personal proof-of-concept account started in January 2020 I’ve turned an initial $34k into over $1M in gross earnings. I feel I’ve proven our strategy of value investing with asymmetry and finally decided to launch Blue Outlier Capital to begin to invest on behalf of my LPs.
You have a very atypical background for a fund manager. You’ve worked in the Navy – thank you for your service – and worked in Israel at BDO, had a short stint at Amazon, and are in your 20s. How does your background affect your investing style?
I think it makes me more open-minded and independent, which leads me to be a better investor. I think hedge fund performance suffers and is often correlated because many of these investors go through the same experiences, come from the same places, and speak in the same circles. These forces cause many investors to see things similarly. Some of the investors I look up to the most are fiercely independent and cognizantly stayed away from Wall Street. Warren Buffett never worked on Wall Street or for any major financial institution after being warned by Benjamin Graham and others that it would do more harm than good. George Soros believed that most of his time should be spent reading and reflecting as opposed to talking to brokers and market participants. Fellow Tennessean John Templeton famously lived in the Bahamas and received the Wall Street Journal a few days after publication. He attributed much of his performance to not reacting emotionally and seeing things independently from a higher perspective. I think this is increasingly difficult to do when you come from similar backgrounds, live and work in the same circles, and have similar forces impacting your thought process as other market participants.
I was self-taught not only from independently studying markets obsessively since I was a child but by learning straight from the best investors of all time through their literature and interviews. I think my unique upbringing and career path have led me to have a Sam Walton-style strategy, meaning I took pieces of my strategy from many different world-class investors that I thought had it right. I'm a macro-focused value investor that believes that markets are reflexive and inefficient. On top of this, I look for opportunities that maximize risk to reward for a specific investment thesis, sometimes by taking advantage of option model inefficiencies. I’m not afraid of distressed or hated names and will look at them objectively. I avoid speculation or overly aggressive forecasts and prefer to invest in high free cash flow to enterprise value yielding names, particularly in times such as this with heightened inflation.
Can you tell us a little more about the systematic inefficiencies you see in the options market? What is your strategy in that market?
There are numerous examples of market makers inefficiently assigning probabilities to potential outcomes. A good example of this (but there are many) are situations of binary outcomes such as court cases not being reflected effectively in option prices. John Bender and James Mai are the pioneers I know in exploiting these inefficiencies.
The job of a market maker is very difficult, and I have nothing to contribute on how to do their job better. I believe in 99% of the cases they do it the most effective that can be done at scale, particularly in short-term options where the majority of option volume is concentrated. I also think that short-term option prices are relatively efficient, and the odds are rarely on the side of the option buyer. I very rarely find instances where I believe an investor on the other side of the market makers has an asymmetrical edge. However, there are instances where the assumptions that are made by option pricing models force option prices to conflict so much with my forecasts that the risk to reward is skewed. When my forecasts in a name conflict with a wide enough margin of safety with what the option price is implying, I can generate better risk to reward through the strategic use of options.
One of the assumptions that options models make is that stocks adhere to the random walk theory, which results in a normal distribution of outcomes. They also make assumptions around volatility, that implied volatility is best reflected through historic volatility, and that volatility is mean reverting. Both assumptions are fair and effective at scale, but there are sometimes opportunities that can be exploited where this isn’t the case. I agree with John Bender that the most effective option models are done on a case-by-case basis by intimately knowing the situation. When my own projections differ with a wide enough margin of safety from what the option prices are implying, I will consider investing through options that offer the best risk to reward for my thesis.
What are two or three interesting ideas on your radar now?
I believe it’s a tough macroeconomic environment for the foreseeable future. High inflation and elevated interest rates are going to be with us for much longer than many expect. In the past few decades, we've benefitted from enormous deflationary forces that are now acting as inflationary headwinds, both in commodities and labor. The geopolitical environment is forcing a reversal in longstanding globalization trends toward onshoring. Onshoring is going to be inflationary, especially as we've had too many people in the last few decades going into white-collar positions of little real productive value. We have a shortage of blue-collar workers and tradesmen, and I expect this to get progressively worse.
Outside of labor, we're also contending with years of severe underinvestment in commodities. We benefitted from years of unsustainably depressed energy prices from technical advances and oversupply. Effects from oversupply, covid, and ESG have raised the cost of capital for many miners and commodity producers and have forced the closure of producers, mines, and hydrocarbon power plants prematurely based partly on overly optimistic forecasts.
Oil gets a lot of attention because of its visibility and association with the inflation of the 1970s, but it’s the hydrocarbon that’s risen the least this cycle, and the one I’m least concerned with. Oil has given up much of the gains of the year, and is still well within its historical range. It’s been much higher than these levels previously with a minimal impact on overall inflation. Electricity prices have a much more pronounced impact on inflation. LNG and coal are the marginal molecules for electricity generation, with coal benefitting over LNG through needing much less import/export infrastructure compared to LNG terminals. While oil is comfortably in a historical range, coal prices are multiples of what they've been historically, with the forward curve suggesting these elevated prices are going to continue well into the future. With coal prices at record highs, by extension electricity prices globally are very elevated. High energy prices are a tax on the whole economy, and I expect the global economy to continue to struggle as these forces affect consumers. The federal reserve’s own forecasts don't have them reaching their target of 2% inflation until 2025, and I believe this to be overly optimistic. Even if we do have a recession, I expect these drivers of inflation to stubbornly persist, particularly in Europe. Amongst this backdrop, I've concentrated my portfolio since the start of the year, have taken shorter-term moves, have found fewer opportunities for the use of options, and have kept a much higher level of cash than usual.
In this environment, I think there are still opportunities selectively in energy. Some O&G producers are beginning to have their valuations stretched, particularly with the weakness in the underlying commodity. I think the best opportunities are in coal, particularly in high calorific value coal which is a suitable alternative for replacing Russian coal exports to Europe. As we’ve recently witnessed, demand for electricity, and by attachment LNG and coal, is very inelastic. The EIA forecasts global energy consumption to grow by 50% by 2050, driven primarily by developing nations in Asia and Africa. Alongside this growth in energy, the EIA forecasts coal usage to rise by 15%, with my expectation of this being underestimated from overly optimistic forecasts for future renewable usage. They also forecast total coal demand, which hit a record in 2022 for the first time since 2013, to grow globally until at least 2025. Developing countries are expected to continue to utilize coal as a cost-efficient baseload power source as they continue to develop their energy infrastructure. Despite the currently elevated prices of coal along the futures curve stretching years in the future, there are still high-quality companies going for less than 2.5x 2023 cash flows.
My favorite is Consol Energy (NYSE: CEIX — $2.27 billion), a differentiated coal company with top-quality management and strategic assets that are uniquely suited for export.