Month: September 2016

Paul Tudor Jones is one of the most emblematic figures in the hedge fund industry. His best percentage returns happened during severe market corrections: 126% after fees in 1987 when U.S. markets lost a quarter of their market cap in one day. 87% in 1990 when the Japanese stock market plunged. 48% during the tech crash of 2000-2001. He returned 5% in 2008. His funds have underperformed in the past 8 years. He charges 2.75% management fee and 27% performance fee, which significantly above the industry average of 2 and 20.

Outside of financial markets. PTJ founded the Robin Hood foundation, which attempts to alleviate problems caused by poverty in NYC.

The biggest conundrum when studying successful money managers is do you pay attention to what they are doing today or do you focus on what they were doing before they became widely popular, were managing a lot less money and had a lot higher returns?

Here PTJ talks about how new powerful trends often start – basically, a big price expansion from a long base.

The basic premise of the system is that markets move sharply when they move. If there is a sudden range expansion in a market that has been trading narrowly, human nature is to try to fade that price move. When you get a range expansion, the market is sending you a very loud, clear signal that the market is getting ready to move in the direction of that expansion.

PTJ on risk management

If I have positions going against me, I get right out; if they are going for me, I keep them… Risk control is the most important thing in trading. If you have a losing position that is making you uncomfortable, the solution is very simple: Get out, because you can always get back in.

I am not sure he can do that today with the size he is trading. The approach that made him an investing legend might not be the approach that he is using today. He is trading a lot more money and size can change everything, especially when you trade other people’s money.

PTJ is famous for the saying “losers average down losers” and yet if you look at his hedge fund’s record, he dollar-cost averages all the time. Again, the size of his fund has forced him to change his market approach. You can’t just get in and out from a billion dollar position whenever you decide to. There’s not enough liquidity and if you don’t invest enough in your best setups, you are guaranteed to underperform after management fees. It is normal to ladder in and out when you trade with size.

When you are trading size, you have to get out when the market lets you out, not when you want to get out.

That cotton trade was almost the deal breaker for me. It was at that point that I said, ‘Mr. Stupid, why risk everything on one trade? Why not make your life a pursuit of happiness rather than pain?’

Another popular speculator, Jim Rogers is often quoted saying that “he has never met a rich technician”. Well, here’s PTJ on the value of technical analysis:

Markets have consistently experienced “100-year events” every five years. While I spend a significant amount of my time on analytics and collecting fundamental information, at the end of the day, I am a slave to the tape and proud of it.

I see the younger generation hampered by the need to understand and rationalize why something should go up or down. Usually, by the time that becomes self-evident, the move is already over.

When I got into the business, there was so little information on fundamentals, and what little information one could get was largely imperfect. We learned just to go with the chart. Why work when Mr. Market can do it for you? These days, there are many more deep intellectuals in the business, and that, coupled with the explosion of information on the Internet, creates an illusion that there is an explanation for everything and that the primary task is simply to find that explanation. As a result, technical analysis is at the bottom of the study list for many of the younger generation, particularly since the skill often requires them to close their eyes and trust price action. The pain of gain is just too overwhelming to bear.

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I teach an undergrad class at the University of Virginia, and I tell my students, “I’m going to save you from going to business school.  Here, you’re getting a $100k class, and I’m going to give it to you in two thoughts, okay?  You don’t need to go to business school; you’ve only got to remember two things.  The first is, you always want to be with whatever the predomianat trend is.

My metric for everything I look at is the 200-day moving average of closing prices.  I’ve seen too many things go to zero, stocks and commodities.  The whole trick in investing is: “How do I keep from losing everything?”  If you use the 200-day moving average rule, then you get out.  You play defense, and you get out.

Trading manias and crashes cannot be taught. It can only be experienced:

There is no training — classroom or otherwise — that can prepare for trading the last third of a move, whether it’s the end of a bull market or the end of a bear market. There’s typically no logic to it; irrationality reigns supreme, and no class can teach what to do during that brief, volatile reign. The only way to learn how to trade during that last, exquisite third of a move is to do it, or, more precisely, live it. Fundamentals might be good for the first third or first 50 or 60 percent of a move, but the last third of a great bull market is typically a blow-off, whereas the mania runs wild and prices go parabolic.

He looks for great risk/reward setups. Sometimes, those setups are near market’s major turning points:

I look for opportunities with tremendously skewed reward-risk opportunities. Don’t ever let them get into your pocket – that means there’s no reason to leverage substantially. There’s no reason to take substantial amounts of financial risk ever, because you should always be able to find something where you can skew the reward risk relationship so greatly in your favor that you can take a variety of small investments with great reward-risk opportunities that should give you minimum draw down pain and maximum upside opportunities.

I believe the very best money is made at the market turns. Everyone says you get killed trying to pick tops and bottoms and you make all your money by playing the trend in the middle. Well for twelve years I have been missing the meat in the middle but I have made a lot of money at tops and bottoms.

Christian Siva-Jothy was Goldman Sachs Group Inc.’s co-head of proprietary currency trading until 2004, when he launched his own SempreMacro fund. He closed his fund in 2011 after losing 27% in 2009 and 8.7% in 2010.

Here’s Siva-Jothy on why he closed his fund:

In this business you are only as good as your last few trades,” Siva-Jothy wrote. “Mine have not been very good. Whether I have lost my edge or simply need a break after 23 years I am not sure, but I certainly hope it is the latter.

No one gets paid for originality

Generally, I can’t see more than a year ahead because things change so rapidly it is very difficult to have a 5- to a 10-year view. I have a rolling one-year view of the world and I impose discipline on myself by keeping a trading diary. Every morning, I go through the same process: If I have any positions on, I ask why do I have the positions? What has changed?

Putting on positions because someone really smart that you respect has it on is a recipe for disaster because you don’t know why you got in or where to get out.

No one gets paid for originality — you get paid for making money.  I am happy to take other people’s good ideas and run with them, AS LONG AS I UNDERSTAND EXACTLY WHY I AM IN THE TRADE.

The way to make money is to chip away at small trades and then lever up when something big comes up.

I am a great believer that there are three or four major macro opportunities every year. If you catch one, your return will be in the high single digits; if you catch two, you should be up somewhere between 10 and 20 percent; if you catch three or four, you are doing incredibly well.

One of the most difficult things about trading is not to trade. That’s probably one of the most common mistakes that people starting out in this business make. Overtrading is as bad as running losing positions for too long.

On how to manage risk

To me, risk is about liquidity, and that is one of the reasons why I am never short gamma.

Markets can be unbelievably slow to figure out the consequences of big events that there’s no script for.

Implied volatilities are always massively undervalued during big events.

I learned not only not to sell options, but to actively look for options to purchase in times of stress and dislocation.

History can be a useful benchmark but only if everything is put into the right context

People spend far too much time saying things like, “This is what happened in 1987 and this looks very similar so I’ll put the same trade on” or “This is what happened in 1994 when the tightening cycle started; therefore the same thing is going to happen this time.”. I don’t like this approach. Markets are dynamic and people’s reactions are different. It’s much more subtle and nuanced that looking at what happened the last time.

Risk more only when you have won your right to do so

My philosophy has always been to trade up when things are going well and you have a high-confidence view. There’s a big difference between going from 30% to 20%, and going from zero to -10%.

From zero to minus 10% is an unbelievably meaningful drawdown. On the other hand, if we are up 30-40%, I am not going to be worried about a 10% drawdown as long as we’re being rigorous.

Confidence is a very, very dangerous thing. Simply because you’ve had a god run doesn’t mean it will continue. In fact, once you’ve had a good run, you’re at your most dangerous. Markets can take it aways as easily as they give it.

Source: Inside the House of Money, Steven Drobney

David Tepper has been one of the most followed and admired hedge fund managers for the past decade. He has the folksy wisdom of Warren Buffett, the analytical deepness of Jim Rogers, and the trading acumen of George Soros. He launched his fund Appaloosa in 1993 with $7 million of his own and $50 million outside money. Since then, he has averaged an annual return of 30% after fees. He invests in high yield bonds, distressed debt, and equities in the U.S. and emerging markets.

Tepper explains his investing philosophy with the phrases “trees grow” and “Those who keep their heads while others are panicking do well.” In other words, growth is natural and optimism tend to get rewarded over time. He is accustomed to invest a large portion of his portfolio into a single idea.

Tepper made most of his money out of the recoveries from big market corrections – emerging markets in 1997, the tech crash in 2000-2002, the financial crisis in 2008. Not during, after. His fund lost 25% in 2008. Made 120% after fees in 2009.

Big corrections create big opportunities. As Peter Lynch said a long time ago, “It is not entirely clear what causes deep market corrections, but without them, many of the best performing long-term investors would have never achieved their spectacular returns.”

It seems Tepper’s market approach has changed from being a trend follower to being a deep value investor. He was short going into the 1987 crash.

Going into the crash I had set up my entire portfolio as just short – I had no long positions. I made a fortune during and after the crash. It was very cool.

We don’t really buy high-flyers. We buy before they get high-flyers.

Patience and Confidence to act on your own analysis are key.

The main thing that makes Appaloosa stand apart from the pack is the depth of our analysis and the fact that we’re not afraid to be the first one to act on our convictions. If you look at our history over the years, we are usually the first mover in a country or situation, time and time again.

For better or worse we’re a herd leader. We’re at the front of the pack, we are one of the first movers. First movers are interesting, you get to the good grass first, or sometimes the lion eats you.

We’re value-oriented and performance-based like a lot of funds. But I think what differentiates us is that we’re not afraid of the downside of different situations when we’ve done the analysis. Some other people are very afraid of losing money, which keeps them from making money.

Tepper likes to replay his losses in his head:

It is the only way you learn from your mistakes.

Tepper says that losing 29% ($80 million) on Russia when Russia defaulted after an IMF deal “the biggest screw-up in his career”.

I’ve made a lot of bad trades.

The worst trade we’ve made was probably in 1998. It was Russia and we thought Russia could devalue but they wouldn’t default. But they did both. So we kind of miscalculated that. We were too long and I couldn’t get out of that trade. We were down 20 something percent.

We had huge emerging market and junk positions that we sold down to avoid disaster, so we were able to act fast. Our biggest mistake was not realizing how illiquid markets could get so quickly. Many firms went out of business at the time, and at one point, I wondered if we would be able to survive. That was kind of an interesting lesson for a lot of people.

Tepper bought back Russian bonds after the default in 1999 at five cents on the dollar. He made 61% on that trade:

It was like minting money. It was almost worth all the hell we had to go through.

Size matters. The amount of capital you manage can impact your approach significantly. Tepper routinely returns principle and profits to his investors after a strong year.

The question is what size gets you – except more fees for the manager. But it doesn’t necessarily make the investor more money.

Fixed income funds should naturally be a little bit larger than, say, equity funds. You want to be big enough that you can see everything and small enough that you don’t kill yourself with size. So I think different sizes are right for different types of funds.

Say you want to buy 5 percent of a $2 billion company, and have it be meaningful. That means it’s a 1 percent position in a $10 billion fund. So if you’re an equity fund, if you keep getting bigger and get to $20 billion, that means your position is now only a half percent position. The 1 percent position doesn’t do much for the fund and so the half percent position does half as much. So there’s an aspect to the business, in equity funds especially, that gets funky on size.

No market approach works all the time. There are times to be aggressive and there are times to sit and wait.

Sometimes it’s time to make money, sometimes it’s time not to lose money.

The key is to wait. Sometimes the hardest thing to do is to do nothing.

Tepper keeps a brass replica of a pair of testicles in a prominent spot on his desk, a present from former employees. He rubs the gift for luck during the trading day to get a laugh out of colleagues.

The media says that hedge funds are the new masters of the universe… We’re just a bunch of schmucks.

Tepper is also famous for his charity work:

The more I make, the more I’ll give away.