Long Running Bull Market in Stocks Trumps Super-Star Hedge Fund Managers
Let’s play a little game: If I say “high-profile hedge fund manager”, what’s the picture that comes to your mind? I am guessing you’re probably thinking of guys who bet big and win big, slick millionaires and billionaires with luxury villas, fancy cars, living the high life. Or maybe you’re thinking of Bobby Axelrod, the fictional self-made Wall Street hedge fund billionaire on the Showtime Series, and you’re not terribly wrong. I think a lot of people see hedge fund titans as “insiders” deeply connected to Wall Street with strong insights that allow them to beat the market consistently.
But the reality is that the hedge fund world isn’t all that rosy. Here’s what actually goes on: These managers bet really big in order to attract as much money as they can and, since hedge funds are allowed to remain very secretive, they like playing up their big wins and are loath to their mention their investment losses. So, when their names appear in print, we generally only hear about their big win, and rarely get even a whiff of their deep losses.
But sometimes hedge funds are forced to disclose their inner workings, which enables us curious types to get a glimpse into what goes on behind that heavy curtain of secrecy.
Barron’s recently reported that the $6 billion hedge fund run by billionaire Carl Icahn—a titan in the hedge fund industry— tumbled 18% in 2015 and lost an additional 20% in 2016.
The weak 2016 hedge fund performance of negative 20% was just awful, considering that the S&P 500—which doesn’t even have a manager, it’s just a list of stocks—was up 12%—that’s a 32% disparity in returns. Now you can’t compare everything to the S&P 500 but, in Icahn’s case, I do think it’s a fair comparison.
This weak 2016 performance and these bad results reflected Icahn’s bearish stance because his fund had a sizable short position in the U.S. equity markets and that’s what hurt his results. When you short something it means you are betting it will go down. As we all know, the market went straight up after the election.
The first thing I thought of when I read this was a piece of wisdom from Warren Buffett, that it’s generally a bad idea to bet against the U.S. economy. (Of course, Warren is thinking about this for the long term.) This also brings to mind another investing truism that the market can stay irrational longer than you can stay solvent. This is a tricky idea, but it’s so true when you’re speculating. Not only do you have to have the direction right—betting for an up market or a down market like Icahn—but you have to get the timing right, meaning that though you may be right in the long term, you may go broke first. So being right, but getting the timing wrong can be a disaster. I think that’s what happened with Icahn…well, we’ll see because maybe the market in the future will go down and his bets would have been right, but they were terribly wrong in the short term and he had to take his losses.
Also, I can’t escape the irony that Icahn, who was one of Wall Street’s most prominent supporters of president-elect Donald Trump, failed to foresee and capitalize on the postelection market rally in stocks. Icahn said he bought “a lot of stock”—that’s a quote—in the market selloff that immediately followed Trump’s surprise win—I think the market sold off about 4 hours—I suspect the truth is slightly more nuanced, that those purchases may have simply reduced his investment fund’s net short position.
But the bloodbath doesn’t stop with Icahn. Another hedge fund billionaire, Bill Ackman, also lost a lot of money over the past two years after he publicly tangled with Icahn over Herbalife (HLF), the controversial nutritional company that Ackman has likened to a pyramid scheme because of its sales practices. Ackman’s publicly traded offshore closed-end fund, Pershing Square Holdings (PSHZF), was off 13.5% in 2016 after a 20.5% loss in 2015. Ackman, however, had a much better 2014, gaining 40.4% while Icahn’s fund lost another 7.4% in 2014.
Also, it was just recently reported that George Soros, the famous hedge fund manager who made his name betting against the Bank of England—and winning—lost $1 billion due to the Trump rally. Now, if there is a silver lining to Icahn’s losses, it’s that the losses were basically borne by Icahn because a majority of his fund’s money—almost $4.1 billion of the $6 billion—is Icahn’s own. He closed and returned the money to outside investors in 2011. I think Icahn’s going to be alright, but, nevertheless, at least, a lot of other people weren’t hurt.
Icahn sold the fund’s big position in Apple (AAPL) last year after a sizable gain… but even there, Icahn would have been significantly better off had he not sold his Apple stake, because Apple shares have gained 5.3% in January 2017 alone. Though Monday morning quarterbacking has its limitations.
If you do the math for Icahn, his loss in 2015 of 18% followed by 20% in 2016, brings a dollar invested down to 65 cents. Now, in order to get back to even, you have to earn 35 cents (the difference between a dollar and 65 cents) you have to earn that 35 cents, but you only have 65 cents invested. So now you have to figure out, “If I need to make 35 cents on 65 cents, what kind of rate of return do I need to break even? And the answer is, you need a whopping 55% return just to get back to even, so those deep losses can really hurt.
Now here’s my final investing truism for the day: Losses are far harder to recover from because they require a higher percentage return just to break even.
While the perceived success of hedge fund managers excites a lot of traders into betting on short-term market moves, you’re always better off—financially and emotionally—if you stick with a Buffett-like long-term investing approach.