InvestorLetterPalooza Weekend
I have a few takeaways from the recent experience:1. Fundamental long/short, similar to statistical arbitrage last year, became a victim of its own success. The self-reinforcing cycle of more and more money going to firms with similar bets and strategies caused excessive crowding in positions, styles, and approaches.2. Regardless of strategy, what separates money managers is their ability to adapt, their flexibility, and their humility. While stock selection generally works, by itself it is not sufficient to succeed in different market environments. Timing, market feel, and risk management skills are vastly more important and these are what investors should be paying for. In the ultimate example of market timing by a long only investor, Warren Buffett became extraordinarily wealthy by going to cash prior to the massive bear market in the 1970s.
3. The hedge fund industry is going to experience a massive wash out with many firms closing. In our last letter, we said that several firms might go out of business due to the unwind of the long energy/short financials bet. Now we think it will be more than 50% of all funds led by the overcrowded long/short equity space. It is similar to the consolidation we are seeing in the banking sector. There is no need for 8,000 banks in this country or 8,000 hedge funds.
4. After the de-risking period is over and positioning is clean, the returns for the survivors are likely to be extraordinary. We went back and looked at the returns of major hedge fund strategies including converts, merger arb, emerging markets, event, long/short, multi-strategy, etc., over the past twenty years in the year following negative performance in that strategy. There were 22 occurrences of down years between the various strategies. In 21 of the 22 cases, the following year’s performance was positive – with an average return of 22%. History is no guarantee, but I would bet on above average returns in long/short and other fundamental strategies next year.
The behavior of some seasoned businessmen and CEO’s in the public eye is particularly disturbing. When executives go on TV or give interviews in the papers where they blame short selling or mark-to-market accounting for their companies fundamental problems it really sends a very strong message to policy makers. The message is that business people are fair weather capitalists who want all the upside when times are good and then lots of new regulations and bailouts when they have to deal with their previous mistakes. When we ask politicians to solve our problems they are rightly going to assume that we don’t know what we are doing and need to be managed and regulated at all times.
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