Friday, August 12, 2011

Four days and roughly flat

After four strange days this week we have made some mistakes (including owning a lot of Bank of America), cleverly covered some shorts and bought some longs on Monday (but limited our trading because of blind fear), made a few more mistakes, had some luck (I mean really good luck) and guess what: we are flat.

We are down low single digit for the month - but hey - I reckon there are a lot of people who would swap.

We were never "threatened" meaning there was little risk of what Warren Buffett refers to as "permanent loss of capital" but it was an altogether uncomfortable experience.

But I am going to tell you something that most hedge fund managers won't admit: the difference between flat and minus seven percent on a week like this one is three parts luck and one part good judgement.

The really big negative surprise

The really big negative surprise from the week was the extent to which we were vulnerable to general hedge-fund liquidation. Our shorts - usually higher beta than our longs - and a source of most of our profits this year - just did not give us the hedge. Hedge funds were liquidating - either to meet margin calls or just to meet large anticipated redemptions. They were selling the most liquid stocks and some were buying back higher short interest stocks (hence those being conspicuously stronger than market).

In most markets our portfolio has relatively low beta (I think about 20-30 percent) meaning if the market drops 50bps we expect to be down 10-15bps and anything different is "alpha". This week we tracked market to a much larger extent and on one day (Wednesday) we actually fell slightly more than market in the first hour. I was genuinely and unpleasantly surprised.

The luck

We had two bits of luck during the week. Firstly our put-option position on Trina Solar paid off big time even though the thesis was mostly wrong.  We covered half the position. That was worth a few points. We have a changed thesis which we are very comfortable with and have positioned differently for the changed thesis.

Second we have a large (and sometimes discussed) position in News Corp. Good results sent the A class share up 18 percent. The results were driven (yet again) by Cable TV Stations. Fox News may or may not be fair and balanced. Whatever: it is extraordinarily profitable.

Logitech: another thing we got wrong

I pretty-publicly lost a fair bit of money on Bank of America. It was for a while our biggest position and whilst we trimmed some we have not played it well.

But I am just as upset about Logitech. I wrote up our basis for shorting it. I got roundly panned as an idiot on Business Insider (see the comments). I sat with the position for a while - but the results were slightly different to how I anticipated and I thought I might be wrong and covered.

Here is the six month stock chart:



Being wrong and losing money: that is part of the game.

Being right and not making money: that is really annoying.

Now I can't even remember the reason why we covered Logitech. It seems so silly... and maybe had I had the flu that day or a sprained ankle we would not have covered it. And the fund would be slightly more profitable.

Lessons

Day to day there is a lot of luck in this game. But if you avoid being stupid (owning Logitech for instance as it zoomed towards obsolescence) you will do OK over the long run.

Just make sure that there is nothing in the short run that can truly hurt you.

And be smart - really smart - but try not to be "too smart". That is a hard judgement.

Remember the difference between flat and minus seven this week is dumb luck.

And this week we were lucky and we were not too smart. Which - from the perspective of our clients - is a good thing.



J

16 comments:

Anonymous said...

Go to Marketwatch. France is about to ban short selling on the banks. You mayh just have a better year yet. The volatility alone may create both some good short and long positions. Methinks the market is heading down tomorrow.

http://www.marketwatch.com/story/four-european-countries-impose-short-selling-ban-2011-08-11?link=MW_home_latest_news

By the way, I have been reading you for the better part of a year. Never feel like your posts are not read. I hope to learn as much as possible before you depart with your well-gotten gains.

Reg said...

i hear you

and it isn't just this week
as smart and as hard working as i am and as good as my own results are when i look back at how i got here i often can't explain my best results

famously, luck was the one quality bonaparte was looking for in the generals he promoted

may you continue to be lucky

but don't forget to burn a joss stick every now and then to propitiate the gods

Anonymous said...

"Remember the difference between flat and minus seven this week is dumb luck."

Refreshing! For most people, profits are due to skill, knowledge and being smarter than the market, where losses are caused by bad luck.

Anonymous said...

John,
as one of my fellow long/short guys used to say to me ... are you wrong for the right reasons or wrong for the wrong reasons!

Anonymous said...

I vaguely remember (CE: but it's so vague that I could be imagining it) a study which took pretty much all portfolio managers it could get its hands on, and showed that their performance was more or less normally distributed (adjusting for fees and suchlike). That to me is a very clear signal that majority of the performance is a blind luck - maybe even more than those 3 parts in 4.
Which is why I will not pay percentage-based performance fees (especially if they ignore downside).

Nick said...

John,

As ever your honesty is extremely refreshing.
Our shorts too offered absolutely no downside protection and materially underperformed.

We had multiple cyclicals who reported excellent Q2s, raised guidance for the year and were down 15-20% on the day.

We utterly mis-read the ferocity of the "screw the valuation just sell everything and get into defensives" trade.

We were 25% net long and felt like it was 100%+. Very odd, but as ever, obvious in hindsight.

On LOGI.
I seem to keep forgetting this lesson.
VALUATION DOESN'T MATTER when estimates are going down.

LOGI is still generating cash and now has 40% of the market cap in cash so it is very far from a zero - BUT NO ONE CARES.
Printed EPS is too high and while that remains true, the short will work.

As an aside, the commenters on BI appear to be undeniably huge morons. I would take being panned by them as 100% conviction that you are right.

"LOGI products are laser etched" I mean, seriously? That's how you make an investment decision?
"2010 PC growth is strong?"
After 2009? Really? Really, Sherlock?
What about 2011? Any views on that?
Oh - tablets rule. And PCs go into reverse. Well that won't matter for LOGI no...

I was completely wrong on LOGI. I thought that tablets would need peripherals as much as laptops.
WRONG.

Keep up the good work. And more importantly for us, keep blogging about it!

Ric said...

John
A tangent - have you followed the CER v. HOGS tussle?

John Hempton said...

Nick

That shorts offering no protection thing was bluntly frightening.

Because it is only one step from there to the longs-go-down, shorts-go-up nightmare.

Usually a long-short fund becomes LESS LEVERED as the market goes down. If you go through the more-levered-as-the-market-goes-down then the losses become threatening.

J

Robert in Chicago said...

We had a similar experience to yours, for roughly similar reasons. We are flat for those four days. We had some better luck/positioning than you around the edges (we've never touched BAC; our shorts "worked") and some worse (we were short calls for the three shorts down the hardest due to high borrow cost & high put cost, so their 30-40% down days earned us "only" 10-15%). But bigger picture, we run a portfolio fairly similar to yours, so we are not surprised we had similar results.

And that is why I disagree with your post's primary point, even though luck generally plays a large part in fund performance. You and we both run portfolios with low leverage and own stocks (and in our case, other things) that we believe should do well even if the economy and markets tank again. That gives us both the freedom to sit tight on the longs and cover shorts when the dump comes. Ending these four days roughly flat with the market roughly flat should be the expected outcome. It is due to neither luck nor brilliance; it is simple conservatism.

(BTW we were also short LOGI and covered LOGI long before you initially posted on it. We also can't remember why we covered, although I am sure it is my fault, and Charlie is moaning louder than I am).

Ben said...

John,

Congratulations on weathering the storm and on a very strong YTD. With respect to your post: as a value guy, when I think of 'permanent loss of capital' I generally think of it as referring to whether the underlying value of the business/security has been compromised irrespective of how its marked in the portfolio. I'd be curious as to what you meant, but in thinking about that, two questions occurred to me:

1. In your opinion, how does the conception of 'permanent loss of capital' apply to a short position?

2. I could see how one could argue that investors getting spooked by volatility and pulling money would result in a permanent loss of capital from *their* perspective. Does that concept come up much when you think about the term?

- Ben

jimmy james said...

Hahaha, I know what you mean about the hedges. Uneasy feeling, for instance, watching the broader market collapse while a piece of garbage like HRBN just... sits there. Or shows up green on my screen.

A strange week. Only smart thing I did was write some AAPL weekly puts on Monday afternoon at a price where I wouldn't have minded to own the stock. Looks like it will close today well above the strike, so nice profit there.

Kudos on the TSL. Nice detective work.

John Hempton said...

I meant permanent loss the same sort of way... it is of course difficult to see what is "permanent".

I mean is the loss on BofA from $9 to $7 permanent?

I mean really?

Do you know?

---

Now sometimes it is bleatingly obvious. The loss on Citigroup from $50 to $2 was "permanent" because the share count went up 5 fold during the crisis. Old shares were permanently diluted.

The loss you might have made on Longtop, Universal Travel et - they are all permanent.

---

Now imagine a diversified portfolio which is 100 long, 30 short but where the shorts evaporate - ie go near to zero and are covered and the longs go down 50 percent. That is an extreme event.

You are going to be down 20 percent or so.

But that is EMPHATICALLY not a permanent loss in the Buffett sense because you hold your diversified portfolio and 30 percent of original portfolio IN CASH.

And if you spend that cash you own more of the same portfolio at a lower price.

So that is easy with respect to shorts.

---

Alternatively if you get carted awy on a short (it happens) that tends to be permanent BECAUSE YOU HAVE TO COVER.

Shorting is a business where you can permanently lose money and be right in the long run - just because it goes from 20 to zero via 100.

Still complex to answer.

J

Ben said...

John, I covered MOTR before the latest break and was short MWW and covered at $15. Lesson is stay short bad companies when you are right. This week and the last few have been very tough, unless you were net short. Happy for you that you were lucky and partially smart.

The Roller said...

There is that old saw, "I'd rather be lucky than smart". But, luck is fleeting. It comes and it goes.

Besides, there is two sides to the luck factor. Good luck and bad luck.

Smart is forever.

On 'ya, John.

Anonymous said...

J

Any thoughts on NOG now that the 2Q is out?

Thanks

Anonymous said...

BTW did you check out COGO, I think this is a Chinese RTO scam, that you didn't cover yet

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The content contained in this blog represents the opinions of Mr. Hempton. Mr. Hempton may hold either long or short positions in securities of various companies discussed in the blog based upon Mr. Hempton's recommendations. The commentary in this blog in no way constitutes a solicitation of business or investment advice. In fact, it should not be relied upon in making investment decisions, ever. It is intended solely for the entertainment of the reader, and the author.  In particular this blog is not directed for investment purposes at US Persons.