Five Market Insights from David Tepper

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.

Five Market Insights from Scott Bessent

Scott Bessent is probably the only one in the world who worked with investing legends like Jim Rogers, Jim Chanos, George Soros, and Stanley Druckenmiller in different stages of his career. He oversaw Soros’s $30-billion fortune between 2011 and 2015. Last year, he launched his own fund. Here are some of his more interesting market insights:

Short-selling is a unique and specific mindset

I went to work with Jim Chanos, who just did short selling. Jim was always trying to go against the crowd. He constantly picked things apart and looked for what the market had wrong.
One thing Jim was never great at was figuring out why it would end. He never really looked for the catalyst that would change the market’s focus. He was usually right, but what I’ve learned since is that it’s more important to be there when a mania ends, that spotting it early.
What I came away with from my time with Chanos was that you don’t have to be skeptical about everything.
There are also other problems with shorting. There’s a difference between investing or buying stocks and shorting. If you are a long/short player and one of your longs goes down 10 or 20 percent, you’ll buy more. If one of your shorts goes up 10 or 20%, you’ll get out.

On how Soros and Druckenmiller “broke” the Bank of England

The breaking of the pound was a combination of Stan Druckenmiller’s gamesmanship – Stan really understands risk and reward — and George’s ability to size trades. Make no mistake about it, shorting the pound was Stan’s idea. Soros’s contribution was pushing him to take a gigantic position.
With the pound, we realized that we could push the Bank of England up against the trading band where they had to buy an unlimited amount of pounds from us. The plan was to trade the fund’s profits and leverage up at the band’s boundary. The fund was up about 12 percent for the year at the time, so we levered the trade up to the point where if they pushed us back up against the other side of the trading band, we would lose the year’s P&L but not more.
The UK economy was already weak, so when they raised interest rates to defend the currency, the average person’s mortgage went up. They basically squeezed everyone in the UK with a mortgage. When they raised rates from 7% to 12% with the stated goal of defending the pound, we knew it was unsustainable and they were finished.

On his worst trade

Being short Internet stocks too early in 1999. Right trade, wrong time. It taught me the lesson that you can be right and lose all your money. Also, if a stock is going to zero it doesn’t matter where you short it, you’re still going to make 100% because you can short on the way down. You made just as much money shorting $100 million in Enron at $25 as you did shorting $100m at $50. it ‘s better to have more conviction and do twice as much.

Stock Picking is full of macro bets

Recently, I was at a money manager roundtable dinner where everyone was talking about “my stock this” and “my stock that”. Their attitude was that it doesn’t matter what is going to happen in the world because their favorite stock is generating free cash flow, buying back shares, and doing XYZ. People always forget that 50% of a stock’s move in the overall market, 30% is the industry group, and then maybe 20% is the extra alpha from stock picking. And stock picking is full of macro bets. When an equity guy is playing airlines, he’s making an embedded macro call on oil.

In trading, when there’s nothing to do, the best thing to do is nothing

Soros used to give out a lot of money for other people to manage. George wasn’t bothered when people started losing money, but he was always worried that they weren’t feeling the pain properly because it was his money and not theirs. If people managing his money were down in November or December and he saw their trades getting bigger, he’d pull the money immediately. Also, if the manager was down and their trading volume picked up dramatically, he’d pull it. The worst thing you can do when you are having a hard time is flail. In trading, when there’s nothing to do, the best thing to do is nothing.

Source: Inside the House of Money, Steven Drobny

Five Market Insights from Jim Leitner

The right trading mindset

I was absolutely unemotional about numbers. Losses did not have an effect on me because I viewed them as purely probability-driven, which meant sometimes you came up with a loss. Bad days, bad weeks, bad months never impacted the way I approached markets the next day. To this day, my wife never knows if I’ve had a bad day or a good day in the markets.

Learning never stops

I am really humble about my ignorance. I truly feel that I am ignorant despite having made enormous amounts of money. I calculated the other day that I have taken over $2 billion out of the market for my investors and employees so far. That seems like a lot of money and yes, I am relatively wealthy and happy to be independent, but there’s never a day when I feel a lot smarter than everybody else.

An advice to aspiring traders

Aspiring traders should be open to the entire spectrum of market experiences. I never locked myself down to investing in one style or in one country because the greatest trade in the world could be happening somewhere else. My advice would be to make sure that you do not become too much of an expert in one area. Even if you see an area that is inefficient today, it’s likely that it won’t be inefficient tomorrow. Expertise is overrated.

On the benefits of using options

Options take away the whole aspect of having to worry about precise risk management. It’s like paying for someone else to be your risk manager. Meanwhile, I know I am long XYZ for the next six months. Even if the option goes down a lot in the beginning to the point that it is worth nothing, I will still own it and you never know what can happen.

I once owned a one-year option on the euro swap rate that became worthless soon after I bought it. Then, with two weeks to go to expiry, the swap rate came back my way and blew through my strike. After being worthless for 11 months, I ended up selling it for five times what I paid for it.

Short-dated volatility is too high because of an insurance premium component in short-dated options. Longer-dated options are priced expensively versus future daily volatility, but cheaply versus the drift in the future spot price.

Every Friday, we go out and buy one-year straddles. We admit that we’re ignorant but we expect that sometimes, over a year, there will be enough trend that we will make money. So, yes, we overpay for options but that doesn’t mean that we don’t make money. If the option maturity is long enough, trends can take us far enough away from the strike that it’s okay to overpay.

Hedge fund money is not the smart money

The big thing that distinguishes the real money world from the hedge fund world is redemptions. Universities don’t have redemptions, nor do family offices. Both are going to be around for years so they invest for the long-term. Meanwhile, the hedge fund world industry invests for the one to three-month time horizon, which subjects managers to taking inefficiency risk and missing out on opportunities that are longer term in nature.

Source: Inside the house of money, Steven Drobny