Hedgeye Investing Summit Fall 2025 | Steve Diggle, Founder & CEO, Vulpes Investment Management

Here's a comprehensive summary of the YouTube video transcript:

Key Concepts

Capital Structure Arbitrage: Exploiting price discrepancies between different parts of a company's capital structure (e.g., debt vs. equity, convertibles vs. stock).
Long Volatility, Short Risk Strategy: A strategy that profits from increased market volatility while aiming to minimize overall market risk.
Fed Put: The perceived implicit guarantee that the Federal Reserve will intervene to support the market during downturns.
Time Decay (Theta): The erosion of an option's value as it approaches its expiration date.
Discontinuous Markets: Markets that experience sudden, sharp price movements and a lack of liquidity, often without clear fundamental triggers.
Jump to Correlation: The phenomenon where assets that are typically uncorrelated become highly correlated during periods of market stress.
Passive Investing: Investment strategies that aim to replicate a market index, such as index funds and ETFs.
Value Investing: An investment strategy that focuses on identifying undervalued assets based on their intrinsic worth.
Speculation vs. Investing: Speculation involves taking on higher risk for potentially higher short-term returns, often without a strong fundamental basis, while investing focuses on long-term value and growth.

Vulpz and the Relaunch of Volatility Funds

Steve Diggle, founder of Vulpz, discusses the relaunch of his volatility funds after a 14-year hiatus. The firm's name, Vulpz, is derived from the Latin word for "fox," symbolizing cunning and adaptability. Diggle highlights that the decision to re-enter the long volatility space is driven by three primary concerns in the current market environment:

Stretched Valuations: Diggle observes that valuations are "a bit stretched," and most experienced market participants are "disquieted" by the current "rampant bull market" characterized by strong "animal spirits" and a lack of skepticism.
Overreliance on the Fed Put: He believes the market's faith in the Federal Reserve's willingness to support it is "probably too strong." Despite rising rates, Diggle suggests that after the 2022 inflation scare (9% US inflation), the Fed has less room to maneuver if the economy falters, and they are unlikely to rescue speculators unless the economy is in serious trouble.
Catalyst for Volatility (Trump Election): Diggle posits that the election of Donald Trump will be a "catalyst for volatility" due to his administration's determination to "shake things up." This is expected to lead to increased volatility, likely on the downside.

The core of Vulpz's strategy is to be "ready for that" volatility by employing long volatility positions. The key challenge, and Vulpz's unique selling proposition, is to achieve this without suffering significant "burn" or "decay" from time decay (theta) and high carrying costs, which have plagued many hedging strategies.

Historical Performance and Strategy Evolution

Diggle recounts his firm's significant success between 2002 and 2007, where he and his partner Richard McGiddis established an Asian-based hedge fund. Their strategy combined:

Capital Structure Arbitrage: Exploiting anomalies within a company's capital structure, such as the debt versus equity or convertibles versus equity.
Long Volatility, Short Risk Strategy: This was crucial because arbitrage strategies can become problematic during periods of extreme volatility. By being long volatility, they aimed to benefit from market wobbles.

This dual approach resulted in positive returns with negative correlation to the broader market. While they "did okay" between 2002 and mid-2007, the period of extreme market stress from the summer of 2007 through 2008 saw them generate "over three billion dollars" for their investors. This made them the top-performing hedge fund in Asia, as most others were down significantly.

A notable aspect of their 2008 experience was their decision not to gate (impose restrictions on redemptions), unlike most multi-billion dollar funds. This made them a "huge cash ATM" for investors, though Diggle admits he would have been personally better off gating.

The challenge after 2008 was matching those returns, as "risk prices were through the roof," making long volatility extremely expensive. By 2010, Diggle's partner retired, and Diggle sold him his stake. They renamed the firm Vulpz and shifted focus to private equity and venture capital, largely avoiding the long volatility space until early 2023.

Managing Volatility and "Staying on the Pitch"

Diggle emphasizes the difficulty of managing long volatility positions due to "burn" or "cost to carry." He explains that simply buying put options is often a losing proposition, as "90% of put options expire worthless." The strategy to combat this "burn" involves:

Arbitrage: Utilizing arbitrage strategies to offset some of the costs.
Trading Inventory: Actively trading a portion of their volatility positions. Diggle states they keep "a quarter of our inventory for what we describe as traded." This means buying low and selling for a profit, not to capture small gains, but to achieve significant multiples when market dislocations occur. He cites the example of buying credit default swaps on Lehman Brothers debt at 24 cents on the dollar and receiving $91.65 at auction, a 430x return.
Disciplined Profit-Taking: While the goal is to capture massive upside, it's also crucial to take profits. Diggle notes that no one would be thanked for seeing the VIX go from 12 to 60 and back to 12 without taking any profit.

This approach allows them to "stay on the pitch," meaning they can remain invested and benefit from market dislocations without suffering significant decay. This is contrasted with institutional investors who are measured against tight benchmarks and often forced to buy overvalued assets, and individual investors who may buy protection, see it expire worthless, and then avoid hedging in the future.

Market Structure and Discontinuous Events

Diggle and Keith McCulla discuss the evolving market structure and the risks associated with it:

Psychological Constructs: Despite technological advancements, markets remain "psychological constructs" driven by fear and greed.
Liquidity Illusion: The last decade has fostered a belief in infinite liquidity, leading many to assume they can exit positions easily. However, Diggle warns that during crises, liquidity can evaporate. He recalls events like 9/11 and the 1997 Asian financial crisis where markets shut down.
Stop-Loss Limitations: Multi-strats relying solely on stop-losses are vulnerable. If everyone tries to exit simultaneously, there may be no buyers, and stop-losses become ineffective.
The Rise of Passive Investing: The growth of passive funds creates a risk. If these large funds are forced to sell during a downturn, their selling could overwhelm the market, leading to a "doom loop."
Discontinuous Markets and Jump to Correlation: Diggle highlights the risk of "discontinuous markets" where prices can move sharply and illiquidly. He explains "jump to correlation," where normally uncorrelated assets become highly correlated during stress, rendering traditional diversification and risk management tools ineffective. He uses the 1987 market crash as an example of a significant move driven by an evaporation of support and an imbalance of sellers.
Zero Days to Expiration (0DTE) Options: The proliferation of 0DTE options trading, particularly by retail investors, is seen as a significant source of "dry brushwood" – speculative activity that can ignite a larger market fire. This mirrors the speculative fervor seen in 1928-1929.

The Importance of Experience and Risk Management

Both Diggle and McCulla stress the value of experience and a robust risk management framework.

Probability vs. Prophecy: Diggle emphasizes that they are in the "probability business" and "risk management business," not the "prophecy business." They don't predict when a downturn will occur but prepare for it.
Generational Differences: Diggle notes that younger investors, whose risk-taking brain regions are still developing, may be more prone to taking excessive risks in bull markets, often dismissing the concerns of experienced professionals.
"Staying on the Pitch": This concept, central to Diggle's philosophy, means maintaining the ability to participate in markets through disciplined risk management and strategic positioning, rather than being forced out by market events.
The "Thought Experiment": Diggle suggests a thought experiment: "What if all trading stopped in perpetuity? Would you like what you have?" If the answer is no, one is likely speculating, not investing.
Valuation Matters Long-Term: Despite the current momentum-driven market, Diggle believes that "valuation will actually matter" in the long run, echoing the principles of Graham and Dodd.

Examples and Case Studies

Lehman Brothers Credit Default Swaps: A prime example of a highly profitable long volatility trade, yielding a 430x return.
Beyond Meat: Used as an illustration of a hyper-bull market that can evaporate, with the stock market cap plummeting from $10 billion to $45 million. This highlights how even popular trends can lead to significant losses.
1987 Market Crash: Cited as an example of a discontinuous market event driven by an imbalance of sellers and a lack of support, which occurred without a clear external trigger.
2008 Financial Crisis: Mentioned in the context of subprime lending and how a seemingly small corner of the market could trigger a global crisis, emphasizing the unpredictable nature of systemic risk.

Conclusion and Takeaways

The conversation underscores the current market's inherent dangers, driven by stretched valuations, overconfidence in central bank support, and speculative fervor, particularly from retail investors and the rise of passive investing. Vulpz's strategy aims to navigate these risks by being long volatility in a way that minimizes decay and maximizes upside during dislocations. The key takeaway is the critical importance of experience-driven risk management, understanding market structure, and preparing for discontinuous events, rather than relying on predictions or the assumption of perpetual liquidity and central bank intervention. The interview concludes with a stark warning that while the timing is uncertain, the severity of a potential market downturn could be "a lot worse than people imagine."