Ed. Note: As of late April 2014, small caps and high-beta tech names are in steep decline. We are short FB, TWTR, CRM, ARWR and others from higher levels, along with IWM and QQQ (portfolio snapshot 04-28-14). One heavy source of selling pressure, we believe, is the weight of the “Tiger Cubs” — as written up in Strategic Intelligence Report Issue 31 (see below).
Originally published April 12th, 2014, in our Strategic Intelligence Report:
“…The current technology, internet and telecom craze, fuelled by the performance desires of investors, money managers and even financial buyers, is unwittingly creating a Ponzi pyramid destined for collapse.”
“The tragedy is, however, that the only way to generate short-term performance in the current environment is to buy these stocks. That makes the process self-perpetuating until the pyramid eventually collapses under its own excess…”
~ Julian Robertson, final letter to Tiger shareholders, 2000
History does not repeat. But does it rhyme, as Mark Twain (possibly) suggested? Well, sort of. There are certainly flashes of irony here and there. Take, for example, the rise and fall of Julian H. Robertson Jr., one of the greatest hedge fund managers of all time.
Julian Robertson, an accented North Carolinian and charming Southern gentleman (when not losing his temper), spent 20 years as a top-producing stockbroker with Kidder, Peabody & Co. before going off to manage money on his own. In May 1980, at the seasoned age of 47, Robertson and a partner started the Tiger funds with a capital base of slightly less than $9 million. Eighteen years later, Tiger’s assets under management briefly topped $22 billion, with a compound rate of return (after all fees) of 31.7 percent.
It was a fantastic run, not without near-death experiences. But 1998 was to prove the beginning of the end. Tiger was up 17% through September 1998… and then the yen trade happened. Tiger’s short yen bet cost almost $2 billion, an error of gross oversizing (the position was far too large) while being caught out by the LTCM blow-up, a spectacular hedge fund disaster that made the yen go vertical.
Things got worse from there as Robertson, a dyed-in-the-wool value investor (who nonetheless traded macro) felt completely out of synch with the dot com bubble. His “old economy” holdings continued to bleed value, even as dot com names soared to 1999 heights. Robertson predicted (quite correctly, as it turns out) that the turn-of-the-century tech craze would end quite badly, with ponzi-like implosion.
But Tiger was too battered and bloodied to ride it out, and Robertson decided to shut down the Tiger funds in early 2000. Tiger’s $22 billion under management had shrunk and bled to a little over $6 billion by the time the doors shut. Rather than leaving the Wall Street game entirely, though, Robertson stuck around as a trainer of “Tiger Cubs.”
The young and talented analysts Robertson had once hired in droves – he had a fondness for athletes – saw benefit in having their mentor around. Robertson himself was more relaxed running personal money (without the pressure of outside investors to answer to). Over the years, the “Tiger Cubs” – the affectionate nickname for Robertson-trained protégés – did extremely well and amassed hundreds of billions in collective assets. The master had reason to be proud (and was happy to be investing with them).
This is where the ironic part comes in. In his early 2000 shutdown letter to shareholders, Robertson did not just predict the bursting of the dot com bubble. He described the future performance chasing behavior of his own Tiger Cubs. In 2012-2014 these large and pedigreed funds, most with assets in the billions, saw value in generating “short-term performance” by loading up on ponzified social media plays.
“Tiger Cub hedge funds have piled in to loftily valued US technology shares such as Facebook, Amazon and Tesla Motors,” the FT reports. “And last month, as many of these names that had performed so strongly over last year began to fall, these hedge funds suffered heavy losses.” One wonders what Uncle Julian thought.
“All in all, the Tiger Cubs, which represent about 49 hedge funds in total, suffered their third-worst overall month in March since the crisis,” the FT adds, “with only September 2008 and September 2011 having seen sharper falls.”
Tiger Cub Phillippe Laffont, of Coatue Management, had a particularly painful month of March, returning $2 billion to investors after an 8.7 percent drop. “We are investors not traders,” Mr. Laffont said by way of justification. There are plenty of instances where being “not a trader” is not a good thing. In fact, if your fund manager says something like “We are investors not traders” immediately after suffering a large loss, with no sign of stopping the bleeding, it might be wise to hit the exits. Coatue is not having a very good April, and the pain could well get worse.
In various Strategic Intelligence Reports these past few months, we have brought up portfolio contagion risk, at one point using the metaphor of fire suppression. When a central bank suppresses risk, in some ways it is like the forestry service preventing corrective brush fires. As a result of no cleansing fires (or no meaningful corrections), underbrush and dry tinder build up. When a fire starts later on, it is then all the more vicious, having more fuel at its disposal. In markets this is comparable to complacency, and risk appetite, getting artificially extended.
What will the Tiger Cubs do next? That likely depends on what the share prices of Facebook, LinkedIn and Tesla et al do next. If high-beta share prices rebound, there may be hope of relief and resolve to ride out the storm. If the slide continues, however, we could see a full-scale meltdown. The Tiger Cubs themselves now visibly contribute to “black swan” risk, in the same manner LTCM (Long-Term Capital Management) did in 1998.
When LTCM blew up in 1998, the problem was not just embedded leverage. The problem was replicated positions all over the street. LTCM had a reputation as “the smartest guys in the room” for many years. As such, many of their position ideas were copied. When the time came for a forced unwind, the fund was a gigantic sitting duck. Nobody wanted to take the positions LTCM had, because everyone knew those positions were going to get dumped. Everyone further knew that more dumping would be coming down the pipe, by the copycat holders who had made the same trades.
Under more normal circumstances, the Tiger Cubs would be seen as “strong hands” in the high-flying tech names they own, as in “not easily shaken out.” But the beatings have progressed for six weeks now, and morale has not improved. At some point an exposed money manager has to stop the bleeding, or otherwise risk bleeding to death. If the Cubs are seen as switching from “strong hands” to “forced sellers,” even as investors redeem funds, a cascading feedback loop of ever greater losses could result. In a hint of historic rhyme, investor redemptions were a major problem for Robertson too, in the final days of the original Tiger funds. As far as Tiger-owned tech names go, those with a penchant for catching falling knives may instead get a grand piano.
[April 12th, 2014, for issue 31 of the Strategic Intelligence Report]
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