Long/Short Investing

(Travis’s Note:  This article was originally published on July 16th, 2017, and it is being re-posted today, October 28th, 2018, to organize for the archives.  Long/short has had a very difficult past decade, but I believe it is primed for a very good decade ahead).

 

The past several days, I have been working on an article for members of “The Contrarian”, that reviews a generational hedge fund call from 2013, and why this call remains relevant today.

In going through my archived writings, I came across an article I wrote on long/short investing in January of 2016, and I wanted to highlight a portion of that article, specifically my comments on long/short investing.

Here is the excerpt from the January 2016 article:

Reflection On My Long/Short Investment Philosophy

Ever since I learned about Alfred Winslow Jones, the pioneer of hedge fund investing, I was fascinated by the long/short investment strategy. Ideally, it performed well in up- and down-market environments, and separated stock picking skill from general market movements.

During my early career as an investment analyst, I focused on value-oriented investment managers and their philosophies. Some of my favorite investment managers were Mason Hawkins, Marty Whitman, Bob Rodriguez, Dan Fuss, and Jean-Marie Eveillard. Reading their analysis and following their investment strategies influenced and shaped my thinking. The 2000-2002 time frame reinforced my value leaning, as value managers, especially the aforementioned ones, strongly outperformed, as the S&P 500 Index declined nearly 40%.

In contrast to 2000-2002, the dramatic downturn of 2008 treated value investors far differently. Many value investors piled into financial stocks as they declined, attracted by the relatively and historically cheap valuations. Trying to buy value investments in 2008 was akin to catching a falling knife, similar to buying commodity stocks over the last three years (Author’s Updated Note: commodity stocks had a historic reversal and rebound in 2016), and many value-oriented investment investors and firms went out of business.

The tremendous volatility of 2008 also negatively impacted long/short equity hedge fund managers. From my perspective covering hedge fund managers at the time, many long/short portfolios experienced historic volatility and drawdowns, especially in the second half of 2008, particularly in the months of October and November. Observing how these managers responded, reducing gross and net exposure, and emphasizing their highest conviction investments, was an invaluable learning experience.

During 2008/2009, I kept my eyes fixated upon the performance of a select few hedge fund managers. One firm that I followed closely for personal and business reasons was Lee Ainslie’s Maverick Capital. Lee Ainslie, one of my favorite investors, is a descendant in the lineage of the legendary Julian Robertson (another one of my favorite investors), and he sparked my curiosity with how his team structured Maverick’s portfolios. Maverick was founded in 1990, and since inception, it has focused on long/short equity investing, eschewing macro, currency, and interest rates bets.

Part of my attraction to Maverick’s investment philosophy was that it was different from my own investment philosophy. Personally, I have always liked macro forecasts and the trading and investing opportunities that they inspire. My strong 2008 and 2009 performance years were largely the result of my macro market views. Because of their love for macro investing, I have been drawn to investors like Stanley Druckenmiller or John Burbank of Passport Capital, and they have heavily influenced my investment philosophy.

To summarize, value investing, long/short investing, macro calls, and a general contrarian stance have all become critical components of my personal investment philosophy. The struggles I have endured trying to buy historically cheap commodity stocks over the last several years has scared me, and caused me to at least consider a worst-case scenario more than I did prior to this experience (Author’s Updated Note: It has also caused me to heavily research the capital cycle, and members of The Contrarian will know what I am referring to specifically).

The resulting compilation of investment philosophies has been mashed together to produce the Contrarian All Weather Portfolio, my version of a long/short portfolio (Author’s Updated Note: This portfolio has has material out-performance since its December 7th, 2015 inception despite the robust performance in the U.S. stock market). At its heart, stock-picking results, netted out by a SPDR S&P 500 ETF (SPY) hedged position, will drive the returns of the portfolio. A majority of the individual stock selections are value oriented in some fashion. Additionally, there will be a macro theme to the portfolio alongside some macro positioning at the margin.

Takeaway: Long/Short Investing Is More Timely Today

Similar to the late 1990’s, which culminated in a period where growth outperformed value for roughly ten years, the past decade has also seen growth outperform value ironically from 2008 through today, in an environment where stock and bond valuations have become historically extended.

The end result is that expected future real returns today, for both stocks and bonds, are some of the lowest projected real returns in history.

Additionally, with bond yields low in nominal terms, the next significant market correction in U.S. equities, will not see investors saved by bond out-performance, in my opinion.

To close, there is a high probability that a traditional “60/40” equity/bond portfolio or “70/30” equity/bond portfolio will have negative real returns over the next decade.  All investors should think about today’s starting valuations when constructing their portfolios.

William “Travis” Koldus

Disclosure: I am/we are short SPY.

Additional disclosure: SPY short is a hedge position to offset long investments in a long/short portfolio. Every investor’s situation is different. Positions can change at any time without warning. Please do your own due diligence and consult with your financial advisor, if you have one, before making any investment decisions. The author is not acting in an investment adviser capacity. The author’s opinions expressed herein address only select aspects of potential investment in securities of the companies mentioned and cannot be a substitute for comprehensive investment analysis. The author recommends that potential and existing investors conduct thorough investment research of their own, including detailed review of the companies’ SEC filings. Any opinions or estimates constitute the author’s best judgment as of the date of publication, and are subject to change without notice.

My Best Trade Ever, So Far

(Travis’s Note: This article was originally posted on July 8th, 2015, however, the trades described were made late in 2008, and early in 2009.  One learning lesson from this experience, is that if you buy a deep value equity, and you are right, and the situation resolves bullish, your price targets in the depths may be way too conservative, and it is probably better to hold on to this uncovered treasure longer than you think at the time of purchase).

Purchasing Macquarie Infrastructure (MIC) in the first half of 2009 has been the best equity trade of my career thus far:

Dow Theory – My Market Historian History Lesson

(Travis’s Note: This post was originally written on May 29th, 2015, and I am re-posting it today, October 28th, 2018.  Interestingly, both the Transportation Average (IYT), and the Dow Jones Industrial Average (DIA) are both below their 200-day moving averages today, as I write this post, so that is a nail in the coffin for the current bull market).

Dow Theory

Dow Theory takes its name from Charles H. Dow, pictured above, the co-founder of Dow Jones & Company, alongside Edward Jones and Charles Bergstresser. Investors should be familiar with at least two of those three names. It amazes me the longer I write and study market history, how intertwined today’s company names are with important historical figures. Similar to myself, Charles Dow was a historian, and a market historian. He was a firm believer in capitalism, and he frequently used the term “raw capitalism”. He aimed to report the facts objectively, and later in life, he consistently warned his reporters against accepting bribes for free stock promotion, which was common in the 1890’s, and remains common today. At the start of his writing career with the Providence Journalhe specialized in articles on regional history, focusing on New England towns, and the resulting investment implications.

He achieved notoriety for his famous “Leadville Letters”. I have posted pictures of Leadville, above, form the late 1800’s and early 1900’s. Dow’s writings from Leadville were based on an expedition Dow took to Colorado in 1879. He traveled to Leadville by train, over the course of four days, to report on the mining boom that was taking place in Colorado. Eventually Dow left his position writing for the Providence Journal, to head to New York City, where he founded the company that bears his name in 1882. On July 8th, 1889, Dow Jones & Company published the first issue of the Wall Street Journal. Market historians will probably find it interesting that Charles H. Dow ultimately sold his shares of his company in 1902 to Clarence Barron, and that is why the Wall Street Journal and Barron’s are sister publications today.

Charles H. Dow was the featured editorial writer in the Wall Street Journalfrom 1889 till 1902. During this time, he popularized the Dow Jones Transportation Average, which he had originally created in 1884, at his predecessor publication titled the Customer’s Afternoon Letter. The original Dow Jones Transportation Average contained nine railroads and two industrial companies. This index was a predecessor to the Dow Jones Industrial Average, which was formally published for the first time in 1896. Charles H. Dow used these new averages to help identify bull and bear markets. If both averages made a new high, it confirmed that a bull market was underway, from his perspective. However, if their was a divergence, that was a warning sign. Additionally, if both averages made a low, that signaled a bear market.

Calling Angelo – Remembering A Different Time

(Travis’s Note: I posted this article originally on May 22nd, 2015, however, the letter authored in the article was submitted on December 6th, 2007).

This is a flashback to a editorial, which I found this morning going through some research and then I scanned, I submitted to the Wall Street Journal on December 6, 2007. It was written in response to an editorial by Angelo R Mozilo, titled “Calling Fannie and Freddie”, which was published in the WSJ on December, 5, 2007, in which the former CEO of Countrywide implored Congress to temporarily raise the limits it imposed on Fannie Mae, Freddie Mac, and FHA mortgages by 50% in order to stabilize the mortgage markets. Here is my response: