A Hard Year for Heroes (Or, an Ode to Staying Power)
Tuesday, November 22, 2011
If your retirement account is in good shape this year, you are ahead of Wall Street's finest. One of the world's largest hedge funds has nearly been cut in half.
John Paulson made billions with a huge bet on the housing bubble. His success attracted a flood of capital. At the peak, Paulson's funds managed a whopping $38 billion.
In 2011, though, John Paulson made another huge bet on economic recovery -- a forecast that never came to pass.
His conviction, and the size of his bets, turned against him with a vengeance in 2011. At the end of September, Reuters reports, Paulson's largest fund was down 47%. (His other funds are down double digits too, in varying amounts.)
Salida Capital, a Toronto-based hedge fund with a focus on energy and gold, was also cut in half as of September's end (down 49.4%). Three-quarters of that decline came in a single month. Salida had extreme exposure to gold and gold stocks (as did Paulson), and the two-edged sword of leverage cuts deep.
It isn't just those two, though. Many big-name investors are taking lumps in 2011, Institutional Investor magazine reports. Mark Mobius of Templeton Emerging Markets -- down 22%. Bill Ackman of Pershing Square -- down 17%. Value investor Whitney Tilson of T2 Partners -- down 29%. (All these numbers are on an end-of-September basis.)
"Where's the hedging?" jokes Institutional Investor.
A dirty secret of the managed money industry is that, while some funds actually do "hedge" (i.e. take pains to guard against large losses), many of them do not. Given this reality, it might make sense to call them "levered funds" instead.
For investors, it might be useful to distinguish between funds that truly guard against loss, and those whose idea of risk control is "picking the best stocks" or simply "being right."
One could further say there is a style of investing -- call it hero investing -- where the manager bets the farm on a very specific worldview. If that worldview comes to pass, and does so in the right time frame, the result is champagne and roses. But if things turn out other than expected, the results can be awful.
It's been a hard year for heroes. Those making big wagers on economic recovery have seen their investment portfolios battered by top-down macroeconomic shocks. And those expecting full-on collapse have been repeatedly thwarted by last-minute hope jags.
("Stocks rise on Europe optimism," a recent headline read. "Stocks rise on same old B.S.," it should have said, "likely soon to jag down again.")
Are there any useful lessons here? Yes. The first one being, "Don't be a hero -- except in very selective circumstances."
For example: Many who make the long-term gold and silver case advise avoiding too much leverage... or at the very least, keeping it on a tight leash. For most investors, leverage is like dynamite. A little bit goes a long way, and skillful handling is required. Too much leverage, like too much dynamite, is an invitation for blowing up.
The inverse of leverage is staying power. It is very hard to lose a third of your money in a month (as Salida did) if you are focused on staying power. A key aspect of winning the game is making sure you play for a long time -- that you are never carried out.
There are traders and investors who understand this, and hedge funds that understand it too. They maintain staying power by considering the risk first, keeping leverage in check and focusing on asymmetric bets. (This is exactly the kind of thing my colleague Zach Scheidt does, for instance, in Hedge Fund Strategist.)
An asymmetric bet is one in which the downside is low, or limited, but the potential gain is attractive.
Trading strategy examples for limiting risk include cutting losses quickly or structuring trades with options, such that the potential gain is many multiples of the potential loss. Investing strategy examples include a deep value focus, purchasing assets for less than their true worth, and emphasizing staying power (not using too much leverage) so as not to be shaken out.
More than ever, 2011 has proven itself a year for focusing on risk. Fortunately this is a specialty of Insiders Strategy Group, with multiple tools available for limiting downside and maximizing upside.
Justice Litle is editorial director for Taipan Publishing Group. He is also a regular contributor to Taipan Daily, a free investing and trading e-letter, and editor of Taipan's Safe Haven Investor and research advisory service, Macro Trader.
Staying Prepared to Invest
Monday, November 7, 2011
Staying prepared and ready to invest when the markets are down or rolling like a roller coaster is a challenge, but there are a few key actions that will help. There are obvious and the not so obvious steps to take.
When stocks or ETFs or mutual funds are sliding the question always is when will they land and when they do land will there be a deafening splat or will you and the markets pop upright ready to go?
The obvious get ready actions:
• Continue to monitor the markets at your normal pace whether it be weekly or daily.
• Pay attention to key news items like new housing starts, sales of existing homes, unemployment trends and the level of manufacturing. These indicators are important because when people buy a home they usually have to spend more money in the months ahead furnishing or fixing up their new home to match their desires and needs. The more employed mean there is more money going into spending pockets and when manufacturing is climbing employment becomes more stable and even increases which means more spending money in everyone's hands.
• Review your investment software or other means you use to get by signals just as if the market were climbing.
The less obvious actions that will help you grow your portfolio are:
• Evaluate the strategies in your software or the settings in your charts. On a monthly basis for the last few months, or even weekly, which strategies (rules for buying and selling) had the least losses or even made money while the markets dived. Especially compare their results to the S&P 500 so you have a guidepost with which to compare all your groups and strategies. In this manner you will discover when groups and which strategies hold up when times get tough.
• Evaluate the groups or universes of stocks, mutual funds or ETFs you use for your investments. Has the climate changed so that different types will be more likely to climb in the future? If this is the case, have you put together a group of these potential ticker symbols? Unless you have kept a diverse selection of groups on your desk or in your software you are likely to miss the next group or groups of symbols that recover first from the current market slump.
Perhaps the biggest challenge is to keep yourself positive and ready to take action when the opportunity arrives. The easiest way to keep yourself ready is to remind yourself that investing is like going to the exercise club, jogging, hiking, swimming or playing tennis every day. If you skip a day or (gasp) a week you find yourself quickly out of shape and fighting to get back into your groove. It's a lot easier to stay in shape and to stay prepared than to get back into shape or get back to a readiness level for increasing your portfolio.
Author Raymond Dominick is the designer of Dynamic Investor Pro investment software for stocks, ETFs and mutual funds. He has been investing in the markets since his teenage years. An experienced business manager and journalist, he has been a registered investment advisor representative, also a professional photographer who loves escaping to the wonders of Glacier National Park in Montana. View his software at: http://www.dynamicinvestorpro.com/
