One secondary theme in the last couple of weeks has been the extent to which certain well regarded hedge fund managers have had very poor returns, surprisingly poor. The loudest of these has probably been John Paulsen with some reports having him down 47% YTD. I also recall reading that Whitney Tilson was down in the mid 20s but while I could not find that when I searched I did find this quote from him that "nobody lost more money or feels worse about our fund's performance over the past year than we do." Also the Tilson Focus Fund (TILFX) is down 23% YTD. We've also talked at great length about Bill Miller in this context.
In all cases there have been large bets on financial stocks along the way and of course it turned out that the financial crisis, as manifested in stock prices had not ended (and still hasn't) when they put these positions on. There is not much utility in saying someone shouldn't have done something because aside from the fact that it is too late, they did it, they would be lauded as having "done it again" if these trades worked and whatever the size of the bets, they might be smaller than the bets they made in the past that worked--meaning they have have dialed down the risk but it still didn't work out.
The more useful thing to take from this for investors with more modest goals (like just having enough when you need it) could be to understand what will happen to your portfolio if some number of your assumptions are wrong. Assuming a portfolio goes narrower than some combo of SPY/EFA/IWM then there are assumptions built in to the portfolio. Looking out over 12, 24 or even 60 months we might each pick several of our holdings to be likely candidates to be the best performers. It is not very likely that the ones we think will be the top performers will actually turn out that way.
The best example of this I can think of is our purchase of Advanced Auto Parts (AAP) early in 2005. The thematic reason to buy it is pretty obvious and the company seemed like it was sound and it ended up far exceeding my expectations. This is an argument for owning more than just your favorite holdings.
In just owning ten favorites, for example, or concentrating on just several areas the consequences for being wrong are magnified. Add on top of that the consequence that can go with using leverage as appears to have been the case with Paulson. If you need to put 30% into bank stocks because you think they can't go down anymore then you have to realize that is a big bet. BAC is down 50% YTD, GS is down 41% and C is down 38%. No one made big long bets on these names expecting those results but that is what happened and based on the results of the funds there appears to have been no mitigation for being wrong. It doesn't matter if you use a price drop as a trigger to sell or not own so much that being wrong and holding on seriously or permanently impairs your capital (James Montier refers permanent impairing of capital on a regular basis).
This is why when I overweight or underweight a sector I only do so by a few percentage points, why I don't put 15% into any single foreign country and why individual stock positions are usually targeted at 2-3% of the portfolio.
Part of the psychology here is that we are all going to have things we get wrong, it is unavoidable and of course we can't really know what macro thesis will be the one (or more than one) that we get wrong. You're probably not going make a long macro bet on Mexico if you thought it was on the verge of imploding.
Worrying about being wrong is not the right way to go as opposed to worrying about the consequence of being wrong. If in a bad year, personally, you are flat in an up 10% world or down 10% in a flat world is not the type of thing that will necessitate a financial plan re-write. Something like Paulson's down 47% in a down 5% world will.
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13 comments:
Paulson's 'blowup' was no surprise; e.g., http://tinyurl.com/5wz6q2u
Needless to say, one of your assumptions should be that the portion of your portfolio devoted to focused value investing may go down 50% during a segment of a market cycle, particularly one fueled entirely by fear... while remaining a sound investment over a full market cycle... the challenge, of course, is maintaining through that cycle and hopefully adding to those hated, worthless equities (of companies essential to the functioning of modern society) as the fear escalates and the market offers you more and more 2020 dollars for your 2011 dollar...
the challenge, of course, is maintaining through that cycle and hopefully adding to those hated, worthless equities (of companies essential to the functioning of modern society) as the fear escalates and the market offers you more and more 2020 dollars for your 2011 dollar...
Just a smidgen of overconfidence bias?
Just curious, how does one differentiate between the tongue in cheek worthless equities and the truly worthless equities like a Lehman or Bear which sucked in alot of presumably smart guys.
Just my opinion, but I think it is a bit cavalier to just snooze at 50% down with the idea at the other end of the tunnel it will work out just fine when 50% down might just be the precursor to 90% or 100% down for certain types of names.
Most of these managers are making big bets on hated financials essential to the function of modern economies... of course being down 50% is nothing to be "overconfident" about, but if your investments in C, BAC, AIG etc go from 50% down to 100% down I'm wondering how any portfolio might look... and how one would convert that prudent portfolio into the needed rations and ammunition...
Of course it feels different this time and of course it may actually be different this time... but a thought or two from Warren from Omaha and Benjamin from New York are never bad things when attempting to take the longer view in a market ruled by emotion...
but if your investments in C, BAC, AIG etc go from 50% down to 100% down I'm wondering how any portfolio might look... and how one would convert that prudent portfolio into the needed rations and ammunition...
I could EASILY see a world where the shareholder equity in C, BAC, AIG is a big fat ZERO, while MCD, WMT, PG, KO, and PEP are trading at or near all-time highs.
There is a difference between a company performing a necessary function in a modern economy, and the actual value shareholders get. Arguably, with true mark-to-market accounting of the real value of the "assets" these are all zeros right now.
OK he screwed up, but the 47 % was likely over a week ago. The market is up 12% last I heard and my portfolio is up roughly 20% from mid day Tuesday. others may be down closer to 20 to 25% today. If this was a shake out, as I suspect, they may be up by year end.
Time will tell if the big banks go to the moon or the sewer, of course... the important point was to remind people that down 50% should not be "unexpected" at times for the equity portion of one's portfolio... the fact that it is viewed as such highlights the concept that many investors (and investment managers) are too aggressive in their equity allocation... until they are too conservative ;)
Down 50% means it takes a return of 100%, a double, to make it back to breakeven. Just staying the course can do that in a reasonable amount of time during a secular bull although the opportunity costs can be high if you're overweighted in the wrong sector(s).
A secular bear is another matter: Get allocation wrong (or even mostly right in some cases) and just holding on can mean a decade or more before breakeven. In the case of some of these financial names as MikeC points out it can also mean breakeven comes never.
There is no indication this secular bear is done with us although it is possible to make a case that we may be through the worst of it.
One of my favorite portfolio managers (along with our avuncular host of course) is Danielle Park who has had a pretty good take on how to play cyclical moves within a secular bear climate over the years, most recently WRT securitized commodities; e.g., http://tinyurl.com/3wtgswr
To me, today's comments, ...down 47%, up 100% ... yadda, yadda, yadda...are an example of today's incorrect way to view wealth. It used to be that wealth was measured by the income stream investments throw off. Flucuating values were not really too much to be concerned with. I mean really, if someone needs to liquidate all of his investments to meet some future goal, then equity investments probably weren't the correct choice to begin with.
I think even Roger says a good portion of his INVESTMENTS are in fixed income. I'm not a dividend zealot, just a realist that expects values to fluctuate (sometimes wildly).
Now, back to the regularly scheduled programming.
"It used to be that wealth was measured by the income stream investments throw off."
Something of a non sequitur given the previous argument but, yes, among the Rentier Class (cf., http://en.wikipedia.org/wiki/Gilded_Age) collecting thier rents this was certainly true but -- setting aside the (mathematically trivial) observation that a given yield on an asset base reduced by 50% means an equivalent cut in income stream -- that is no longer the age in which we live.
Shorter version: For the vast majority of investors, a failure to increase marketable expertise and capital stock translates into a failure to increase wealth; the math is inexorable in this regard and quite unforgiving.
Nostalgia for what "used to be" does not alter that dynamic (or the math) in the slightest: Increase your asset base or go under ...or possibly devise a better system.
Whatever: Now back to whatever programming floats your boat. [yawn]
What about when yield drops 50% because the value of the asset doubled?
Or better yet, income stream outpaces inflation, yield drops more than 50%, and asset value more than doubles? All without additional investment of capital?
RW, thanks for the link to Danielle. As you stated, another sane voice in the wilderness. I did not see her performance posted. It would be interesting to see how well her approach gets excecuted.
Thanks,
Sam
Danielle's numbers look pretty good (there is a chart on her firms' website), and I enjoyed her interview as well... but of course there is a fundamental difference between top down macro managers who don't believe that you can determine a companies' value by looking at their balance sheet and cash flow, and who therefore use sector instruments to attempt to divine where the market will go before it goes there... and a traditional micro oriented value manager who does believe that you can ascertain a companies' present and potential future value by an informed analysis of the balance sheet and an appraisal of its management...
A 50% decline in the first approach would indeed be distressing, while being an integral part of the latter... and of course an investor who decided to get off of his Ben Graham horse mid-stream and join the quants would be sealing his own fate... respect to both approaches; you just have to understand which one you are comfortable with and can stick with in the worst of situations...
And the macro forecasting approach has so many moving parts, all of which need to be guessed correctly... you have to time your entry point, asset class, sector AND country... and you have to get that call right again on the way out... doing that successfully over a lifetime of investing seems incredibly challenging and never understanding what the intrinsic value of your investments are may lead to a sense of psychological dislocation (which may be preferable for some investors)... whereas Mr Grahams' approach only needs to get one thing right; a companies' price in relation to its value...
Ms Park appears very skilled in her area, and she pays attention to long term trends and the history of the forecasting practice she is involved in... its important for investors seduced by the apparent "safety" of value investing to understand the same things, hence these posts... as Roger has always said, consistency is the key, and as painful as losing may be, sticking with it when the crowd tells you you are wrong (providing you have done your analysis vigorously and correctly) comes with the territory...
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