Author Topic: The 400% Man!  (Read 129516 times)

Parsad

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Re: The 400% Man!
« Reply #290 on: April 23, 2018, 08:54:25 PM »
If any investment manager is touting his or her fabulous returns without mentioning the margin risk he or she took as a fiduciary of his or her clients or is not comparing him/herself to what the index would've done with the same level of margin, I think people should definitely raise an eyebrow.

Showing great returns with margin is really easy.  But it doesn't make it smart.

I'm not opposed to leverage.  For example, generally speaking most of what a PE investor is paying for is not for the investment genius of the manager but  for the cost of capital arbitrage a PE Firm is able to procure, vs. its investors themselves. Hedge funds have an even lower cost of arbitrage, but its far far riskier because of how quickly it can get called back at the worst time.


You said that this wasn't directed at any manager in particular...noted.  I thought I would just clear up the leverage Arlington used on that Berkshire bet...remember, BRKA stock was trading at about $92K when that bet was made and intrinsic value by Allan was calculated at about $190K per A share.  He took a 50% leverage position and clearly explained it to all partners in his annual report.  He also indicated it was the first time the fund had used leverage, but the upside was very high and the downside reflected fully in the price.

Now going back to your comments on leverage...IB allows 5-1 leverage?  If so, that's nuts and I think most investors would still have a losing record doing that, because if they are wrong for any prolonged period, the losses would start to hammer them psychologically.  In fact, I think the average investor using leverage would do worse than the average investor not using leverage...and that's because the average investor is average both analytically and psychologically.  Cheers!
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thepupil

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Re: The 400% Man!
« Reply #291 on: April 24, 2018, 02:33:54 AM »
This is directed at the forum, not really at any particular poster, but I would question, in general, if one should applaud an investment manager margining up 5x and then paying himself on the upside.  If you want to take that kind of risk/reward trade off, just do it yourself.  Lever up with the S&P500 Index.  IB will let you borrow up to 4-5x your equity.

I've come across more than a few funds (no specific names mentioned) that post these astronomical returns and I've looked at their letters and the long thesis where they literally haven't outperformed the S&P500 on the majority of their holdings. (One was even short a bunch of FANGs (which has obviously proved to be a terrible idea over the last 5 or 6 years) and they're still posting these incredible returns. And the only way that happens is with a lot of margin.

Yet, if you then see what you yourself could've done instead with an index or Berkshire levered 5X yourself over the past 8 years, you would have a far better record than them and you wouldn't pay them an extraordinary fee. But that doesn't necessarily make it smart unless you were able to hedge the downside at a low cost.  Berkshire fell 45% from top to bottom in September 2008 - Feb 2009, so this notion that the stock won't trade below the 1.2x repurchase price is not accurate, in my view.  Anything can happen in the markets.  You can't know how others behave.

If you simply had a portfolio margin account, and margin'ed 5 to 1, borrowed at 2% and invested in the index earning 14.5% over the last 8 years, you would've had 10x your money and you would be on the cover of barron's, arms folded looking out a window. And it would work like a charm until you have a 1st quarter 18 type event or a 2008 event or a 1987 event or whatever in which case you stand a pretty good chance of getting a margin call and closing out at a huge loss (depending on your particular portfolio of course).

If you want to take that risk for yourself, then by all means. May be a worthwhile gamble. But why pay someone else to gamble for you?

If any investment manager is touting his or her fabulous returns without mentioning the margin risk he or she took as a fiduciary of his or her clients or not are not comparing themselves to what the index would've done on the same margin, I think people should definitely raise an eyebrow.

Showing great returns with margin is really easy.  But it doesn't make it smart.
I think that you make some good points but you're generally wrong.

First off IB will not let you do 4 or 5x margin. They enforce Reg T margin which is 1:1. In Canada you're actually allowed to have 2:1 margin but IB still enforces 1:1. Of course you can use derivatives to manage that but it's not straight up margin.


https://www.interactivebrokers.com/en/index.php?f=1451

Portfolio margin > leverage than reg t

Shooter MacGavin

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Re: The 400% Man!
« Reply #292 on: April 24, 2018, 05:04:02 AM »
This is directed at the forum, not really at any particular poster, but I would question, in general, if one should applaud an investment manager margining up 5x and then paying himself on the upside.  If you want to take that kind of risk/reward trade off, just do it yourself.  Lever up with the S&P500 Index.  IB will let you borrow up to 4-5x your equity.

I've come across more than a few funds (no specific names mentioned) that post these astronomical returns and I've looked at their letters and the long thesis where they literally haven't outperformed the S&P500 on the majority of their holdings. (One was even short a bunch of FANGs (which has obviously proved to be a terrible idea over the last 5 or 6 years) and they're still posting these incredible returns. And the only way that happens is with a lot of margin.

Yet, if you then see what you yourself could've done instead with an index or Berkshire levered 5X yourself over the past 8 years, you would have a far better record than them and you wouldn't pay them an extraordinary fee. But that doesn't necessarily make it smart unless you were able to hedge the downside at a low cost.  Berkshire fell 45% from top to bottom in September 2008 - Feb 2009, so this notion that the stock won't trade below the 1.2x repurchase price is not accurate, in my view.  Anything can happen in the markets.  You can't know how others behave.

If you simply had a portfolio margin account, and margin'ed 5 to 1, borrowed at 2% and invested in the index earning 14.5% over the last 8 years, you would've had 10x your money and you would be on the cover of barron's, arms folded looking out a window. And it would work like a charm until you have a 1st quarter 18 type event or a 2008 event or a 1987 event or whatever in which case you stand a pretty good chance of getting a margin call and closing out at a huge loss (depending on your particular portfolio of course).

If you want to take that risk for yourself, then by all means. May be a worthwhile gamble. But why pay someone else to gamble for you?

If any investment manager is touting his or her fabulous returns without mentioning the margin risk he or she took as a fiduciary of his or her clients or not are not comparing themselves to what the index would've done on the same margin, I think people should definitely raise an eyebrow.

Showing great returns with margin is really easy.  But it doesn't make it smart.
I think that you make some good points but you're generally wrong.

First off IB will not let you do 4 or 5x margin. They enforce Reg T margin which is 1:1. In Canada you're actually allowed to have 2:1 margin but IB still enforces 1:1. Of course you can use derivatives to manage that but it's not straight up margin.

Second, as long as the strategy is communicated clearly to the investors in the fund I don't see any reason why using margin to generate returns should be a problem. If the investors are ok with it and its risks, game on. Similarly on fees. That is a matter between the manager and his clients. If the clients are aware of what they are paying and they're ok with it why should that be an issue.

Thirdly, a lot of what you base your post on is a fallacy. That the people should "do it themselves". Here's the thing: People don't want to do it themselves. So they have other people do it for them. And yes they pay fees for that. It's just how it is.

1) Actually, you're wrong about the margin.  I have a portfolio margin account.  Lots of people on this board do. But refer to thepupil's post. He's kindly provided the link.

2) Of course.  Do whatever you like. It's just a perverse incentive structure rewarding managers for risk-taking over skill with other people's money.
I take particular umbrage specifically with funds that are underperforming the market on an unlevered basis, risking investor's capital with high levels of margin (and I make a distinction between margin and leverage overall), throwing up good numbers and receiving the accolades from outside investors who aren't paying attention to this "parlor trick". And it happens ALL the time.



« Last Edit: April 24, 2018, 05:28:44 AM by Shooter MacGavin »

Shooter MacGavin

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Re: The 400% Man!
« Reply #293 on: April 24, 2018, 05:27:07 AM »
If any investment manager is touting his or her fabulous returns without mentioning the margin risk he or she took as a fiduciary of his or her clients or is not comparing him/herself to what the index would've done with the same level of margin, I think people should definitely raise an eyebrow.

Showing great returns with margin is really easy.  But it doesn't make it smart.

I'm not opposed to leverage.  For example, generally speaking most of what a PE investor is paying for is not for the investment genius of the manager but  for the cost of capital arbitrage a PE Firm is able to procure, vs. its investors themselves. Hedge funds have an even lower cost of arbitrage, but its far far riskier because of how quickly it can get called back at the worst time.


You said that this wasn't directed at any manager in particular...noted.  I thought I would just clear up the leverage Arlington used on that Berkshire bet...remember, BRKA stock was trading at about $92K when that bet was made and intrinsic value by Allan was calculated at about $190K per A share.  He took a 50% leverage position and clearly explained it to all partners in his annual report.  He also indicated it was the first time the fund had used leverage, but the upside was very high and the downside reflected fully in the price.

Now going back to your comments on leverage...IB allows 5-1 leverage?  If so, that's nuts and I think most investors would still have a losing record doing that, because if they are wrong for any prolonged period, the losses would start to hammer them psychologically.  In fact, I think the average investor using leverage would do worse than the average investor not using leverage...and that's because the average investor is average both analytically and psychologically.  Cheers!

Sanjeev,

On Arlington, fair enough.  I haven't paid much attention to them so I'm admittedly uninformed. The Berkshire repurchase thing was of course a nod to them, so you have a right to clear that up. Personally, if i had been an investor, I wouldn't have been thrilled unless there was a hedge on as well.

On leverage, you're absolutely right.  If you have high amounts and/or the wrong kind of leverage, you WILL impair your capital.  It's only a matter of time. To invoke Munger - there are three ways to go broke: 'liquor, ladies and leverage'.

 



mhdousa

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Re: The 400% Man!
« Reply #294 on: April 24, 2018, 05:43:54 AM »

I take particular umbrage specifically with funds that are underperforming the market on an unlevered basis, risking investor's capital with high levels of margin (and I make a distinction between margin and leverage overall), throwing up good numbers and receiving the accolades from outside investors who aren't paying attention to this "parlor trick". And it happens ALL the time.

I'm curious what funds do this. I know you don't want to name names, but presumably this info is in their letters and out there.

Dynamic

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Re: The 400% Man!
« Reply #295 on: April 24, 2018, 06:22:36 AM »
Debt leverage is powerful in both directions. Clearly with extremely stable companies like regulated utility monopolies, there is scope for the company to use a lot of debt to finance the capital base and boost ROE. Their income stability makes them low risk to bondholders and affords them modest interest rates.

Investment is a lot less certain than those income streams, suffers correlated declines during broad bear markets and usually operates on far lower degrees of certainty of outcome, especially in the short term.

However, I think there are rare times when the upside/downside balance is greatly skewed and the downside is limited. The only problem then might be the timing and the short term price action. The problem with debt is remaining solvent until the intrinsic value of your investments is reflected in market price, and intermediate prices falling even lower could lead to a margin call or similar problem with how the counterparty to your debt views your financial position that can wipe you out completely and multiply that string of great returns by zero.

Sometimes, I think the problems come with duration mismatch. If you have a 10-15+ year mortgage and can be completely sure of meeting the very modest payments to avoid default, an investment that might need 5 years to have its value recognised could be fine to invest some borrowed money against.

But if the counterparty is able to call your debt in at the worst moment you might have to assume that they probably will!

So I think you need to consider the effects of possible short-term market price action very carefully to give yourself plenty of leeway to ensure you can ride out the turbulence without crashing. It's far to easy to be overconfident and get addicted to the juiced up returns when things worked out well for you in the past.

vinod1

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Re: The 400% Man!
« Reply #296 on: April 24, 2018, 07:35:53 AM »
I think having blanket rules in investing is going to only needlessly hurt one's returns. Things like

1. Dont invest in financials (banks)

2. Dont  invest in Tech

3. Dont use leverage, etc.

As investors we accept that majority of the time markets are efficient but can occasionally be inefficient for us to make a profitable investment.

It is generally true that leverage is risky. But if a rare opportunity comes up, say like the banks (BAC, JPM, etc) over the last few years, I would posit that it is less risky to use leverage (use lots of cash + LEAPS, warrants on deeply undervalued businesses) than most conventional portfolios of value investors.

Vinod
The fundamental algorithm of life: repeat what works. –Charlie Munger

Shooter MacGavin

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Re: The 400% Man!
« Reply #297 on: April 24, 2018, 08:29:21 AM »
I think having blanket rules in investing is going to only needlessly hurt one's returns. Things like

1. Dont invest in financials (banks)

2. Dont  invest in Tech

3. Dont use leverage, etc.

As investors we accept that majority of the time markets are efficient but can occasionally be inefficient for us to make a profitable investment.

It is generally true that leverage is risky. But if a rare opportunity comes up, say like the banks (BAC, JPM, etc) over the last few years, I would posit that it is less risky to use leverage (use lots of cash + LEAPS, warrants on deeply undervalued businesses) than most conventional portfolios of value investors.

Vinod

Vinod,

I agree wholeheartedly.  We should distinguish between margin leverage and the concept of leverage overall.  I'll take as much long-term , low cost, non callable leverage as I can get.  Margin is where you can get in trouble. You never know when you're going to get called.  You could be right on your valuation and still get shellacked. 

AzCactus

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Re: The 400% Man!
« Reply #298 on: April 24, 2018, 08:32:34 AM »
Regarding Arlington specifically it's a tad suspect that the accusations come out and the following year they keep their letter private.  He has every right to do so, but the timing is peculiar.


racemize

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Re: The 400% Man!
« Reply #299 on: April 24, 2018, 08:40:55 AM »
Regarding Arlington specifically it's a tad suspect that the accusations come out and the following year they keep their letter private.  He has every right to do so, but the timing is peculiar.

He probably just doesn't want any attention drawn to him anymore.  I wouldn't if some RIA with no information accused me of fraud, particularly if the fund was closed.  Any partner can easily verify with the auditor that he actually has the money in a brokerage account.