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I read two to three dozen books a year on average. Probably at least half are directly related to trading. Some of my favorite reads of the past twelve months are as follows:
- Invisible Hands by Steven Drobny
- More Money Than God by Sebastian Mallaby
- The Quants by Scott Patterson
- The Greatest Trade Ever by Gregory Zuckerman
- The Great Reflation by Tony Boekh
Today though I want to mention a slightly older book – Hedgehogging by Barton Biggs. If you have a natural interest in the history and inner workings of the hedge fund world, as I obviously do, you’ll find Hedgehogging to be colorful, refreshing and informative.
To drill down further, my favorite chapter of Hedgehogging is on “Tim” (not his real name), a lone hand global macro manager who works from a leafy suburb of London.
The concept that brought “Tim” to mind again recently is “staying close to shore,” which basically means keeping your exposure low and your positions light and nimble when you aren’t possessed of deep conviction.
This idea dovetails well with a quote from Andre Gide, who noted that “One doesn’t discover new lands without consenting to lose sight of the shore for a very long time.”
If we analogize discovering new lands to booking large profits, it is conviction that makes such outsized gains possible — the conviction to venture out into the deep waters of concentrated exposure and substantial position size. And so, when you are lacking that conviction — as will happen in the frequent in-between times — you “stay close to shore.”
Anyhow, again, if you haven’t read Hedgehogging it’s well worth the time (if you are into this sort of thing) and also light enough to make good weekend reading. The excerpt on “Tim” is reproduced below.
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IT TAKES COURAGE TO BE A PIG AND TOTIS PORCIS
Today Tim came to have lunch. We were flattered because he is truly a legend in the hedge-fund business. Tim is a slim, dark-haired handsome man of perhaps 55. He speaks softly with a faintly British accent, seems imperturbable, and has beautiful manners. He grew up in Kenya on a coffee plantation, which he still owns. He is a very cultured, erudite man. For most of the 1990s, he had the best record of any major hedge fund in the world. His performance is no longer public, but he is still doing brilliantly. Tim’s portfolio is so concentrated and he uses so much leverage, that his results have immense volatility. But so what? If you are a long-term investor, you should happily take a highly volatile, five-year 25% compound return over a stable 10%, but you have to be able to live with the volatility and not panic when the inevitable bad year comes.
Tim works out of a quiet, spacious office filled with antique furniture, exquisite oriental rugs, and porcelain in a leafy suburb of London with only a secretary. My guess is he runs more than $1 billion, probably half of which is his. On his beautiful Chippendale desk sits a small plaque, which says totis porcis—the whole hog. There is also a small porcelain pig, which reads, “It takes Courage to be a Pig.” I think Stan Druckenmiller, who coined the phrase, gave him the pig. To get really big long-term returns, you have to be a pig and ride your winners.
Tim is a macro or top-down global investor. He studies the world, searching for investment opportunities. He concentrates on asset classes, countries, and major groups of stocks. On one day in June 2003, when he came by our offices, he was long Japanese banks, Russian equities, Treasury bonds, the euro, and Korean equities. At the time, he was short the dollar in a big way, which could mean a position three times his equity. He was also short the consumer staple stocks like food and beverages in Europe and the Unite States. When he lacks conviction, he reduces his leverage and takes off his bets. He describes this as “staying close to shore.
Tim’s modus operandi is the exact opposite of the conventional, fiduciary wisdom. He uses immense leverage, practices enormous concentration, and has no investment organization. It requires nerves of spun steel and great inner confidence to use the kind of leverage he employs. Leverage means volatility, and it means you have a lot less margin of error. For example, a guy like Tim could easily have his fund leveraged up four times. That means if he loses 10% on his portfolio, his equity is down 50%. Once you are down more than 20%, it’s hard to recover, because you are compounding off a much lower base. Suppose Tim was down 10% overall but down 50% on his equity. If he was up 10% the next year, he would still be down 25% from inception, whereas on the same performance the unleveraged fund would be down only 1%. Besides, anytime your portfolio is down more than 20%, your head is seriously being messed with.
Tim is convinced that hedge funds, because of client pressure, have become obsessed with avoiding monthly declines in net asset value (drawdowns). As a result they employ stop-loss limits and all kinds of risk-control mechanisms that mechanically make investment decisions for them. Most of these decisions are bad. They never fight the tape and brag about how market neutral they are. As a result, they become short-term, momentum-oriented traders. He argues that this creates an opportunity for an investor who uses leverage, is willing to accept volatility, and who is long term in his thinking. “Accept volatility and concentration,” he says. “Diversification is an enemy of performance.”
Tim makes another interesting point. “Running a portfolio,” he says, “is a solitary activity. For me it doesn’t work to have partners. In the end, one mind in the dead of night has to make the buy and sell decisions.” Teams, much less groups, are about compromises and they are bound to make less good decisions than an individual who is focused on one portfolio in which his own money is at stake. He says he can and often does make wrong decisions, but at least the decision-making process is uncontaminated.
You would have to truly believe in Tim to invest in his fund, and you would either have to ignore or not be disturbed by the huge performance swings. In 2002 he was down about 20%, then up more than 100% in 2003. At one point in 2004, he was up 18% and then ended up close to 40%. I suspect Tim has a few large investors who have been with him for a long time, and I’m sure he wouldn’t even answer a phone call from a fund of funds. Twice a year he writes a one-page letter describing what he is thinking. It is literally one page! He publishes his net asset value once a week on a secure web site, so his investors, if they want to look, can find out how he is doing.
Tim keeps himself totally inaccessible to all but a few select strategists and analysts. He speaks with other money managers and to businesspeople who are working in the real economy. I don’t think he reads much Wall Street research, but he does look at and pay attention to charts. When I asked him how he got his investment ideas, at first he was at a loss. Then, after thinking about it, he said that the trick was to accumulate over time a knowledge base. Then, out of the blue, some event or new piece of information triggers a thought process, and suddenly you have discovered an investment opportunity. You can’t force it. You have to be patient and wait for the light to go on. If it doesn’t go on, “Stay close to shore.”
Tim usually carries about 10 positions, and argues that the proper way to invest for superior performance is to have a few big bets in which you can develop an edge and that you have real conviction in. Then you must follow them intensely. Recently he told me he had three positions. He was short the dollar by a factor of three times his equity, and he had more than 100% of his equity in Japan, half in the banks, and half in the Japan Topic Index. In addition, he had 200% of his equity in two-year US Treasury notes as an insurance position. Sometimes he also owns a few exotic positions; like right now, he owns a significant interest in a North Korean bank and commercial real estate in St. Petersburg. The bank sells at a third of book value and the real estate yields 15%.
He travels continually. He is a very curious, inquisitive man. He operates almost like a secret agent. For example, Tim has big positions in Russian and Japanese banks. He isn’t just content with the usual fare of company meetings and government officials in Moscow and St. Petersburg. Instead, because Russia is so much about oil, last year he went on a grueling trip for a week in Siberia, visiting the Russian oil companies. With the Japanese banks he employs a number of unconventional sources, and I know he has long-time contacts with the senior management of two of them. He goes to Tokyo probably four or five times a year.
As I said before, Tim thinks investment management is essentially a one-person, lonely, anguished occupation, and that intense personal relationships with the people who work for you are essentially disruptive and a distraction. Your focus has to be totally on your portfolio and what is happening in the world and in markets. Your objective is performance and and not to build an enduring firm or develop brilliant young macro analysts. Almost all of the other really successful hedge-fund managers I know want to create a legacy, build a business that survives beyond them. Often this obsession becomes their downfall.
Tim must be a very wealthy man, but he doesn’t live ostentatiously. He has a house in London and a coffee plantation in Kenya. This is an intriguing question: Why does Tim run money in this extremely stressful, highly concentrated, massively leveraged way? Why does he travel endlessly places like Japan, Russia, and India, which are not exactly luxury locations? He has no partner with whom to share the anxiety, and his performance swings are so immense it must be nervewracking even for an impervious persona. From time to time, one hears wild stories that Tim is facing huge margin calls and is about to be carried out. Of course it is never true.
The only answer I can come up with is that he loves high-octane investing, and I know that he thinks it’s the right way to manage money. He must like to travel. This quiet, austere, gentle man must thrill to the adrenaline rush of spectacular successes and be able to live with the big downs. As an investor in hedge funds, what would you rather have over five years? A very choppy 20% to 25% compound or a steady 10% to 12%?
– Barton Biggs, Hedgehogging
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