In the perception of many people, private investors achieve modest returns, financial professionals high returns, and hedge fund managers astronomically high returns. And indeed there are legendary cases in which hedge funds earned billions: think of George Soros, who earned a billion dollars in a single day in 1992 by speculating against the British pound. In the case of John Paulson, it is estimated that his fund achieved an incredible 15 billion dollars by speculating on a collapse of the property market in 2008. Far less is reported, by contrast, about the downfall of such former star managers. In John Paulson’s case, for instance, investors withdrew a large part of their money again – no wonder, given that his „flagship“ fund generated double-digit negative returns for several years in a row, despite generally rising stock markets.
A similar fate befalls David Einhorn, another former star manager (with a private fortune of 1.4 billion dollars), who became known for a highly successful bet against Lehman Brothers during the financial crisis. Later, however, things did not go so well, and in 2018 Einhorn had to record a loss of 34%. Anyone who goes through the holdings in Einhorn’s portfolio can’t help but think of the footballer’s quote: „First we had no luck, and then bad luck came on top of it.“
Einhorn believed that Netflix was overvalued and bet on falling prices. But Netflix continued to rise. Einhorn considered General Motors to be attractively valued and bought; in 2018 the stock fell. A large position in Bayer? As is well known, Bayer’s takeover of Monsanto ended in disaster for shareholders. It’s also interesting how Einhorn tried to play it indirectly elsewhere: he foresaw – this time even correctly – that cryptocurrencies such as Bitcoin would implode. Since Bitcoins cannot be sold short, however, Einhorn wanted to profit from this at least indirectly and bet on falling prices for computer chip manufacturers. Computer chips are needed to electronically „mine“ new Bitcoins. With the chipmaker Nvidia the bet paid off, but with a large investment in its competitor Micro Devices Einhorn got it wrong: here the price rose by 60%. Einhorn’s speculation on a demise of the electric car maker Tesla likewise continues not to materialise. The list of lost bets seems never to end: even with unknown companies – Norwegian fish farms and reinsurers – Einhorn took his positions with the wrong sign.
We actually find the economic logic of many of his bets quite appealing: predicting low returns for the „glamour stock“ Netflix and high returns for the attractively valued company General Motors follows the logic of „value investing“. quirion, too, follows such an approach. But there are two important differences: unlike Einhorn, we charge considerably lower fees, so that excess returns accrue to the investor and not to the fund manager. And, more importantly still: our portfolios are put together systematically and with broad diversification. The value ETFs we select contain thousands of companies with strong substance. Through this extremely broad diversification, we can rule out the risk of getting it as extremely wrong as Einhorn did with his individual bets.
With investments in bonds, exactly the same pattern can be observed: the former „king of bonds“, Bill Gross, for example, has lately lost a great deal of his lustre. He once managed 300 billion dollars; by now it’s just barely one. Investors withdrew their money not entirely without justification: recent studies show that a good part of the excess return he generated over a long period was down to a fairly simple trick: Gross added bonds with weaker credit ratings to his fund and bet on long-maturity bonds. That these bond classes generate higher returns is, however, generally known, and in quirion’s bond portfolios too we make use of this effect. You don’t need star managers and exorbitant fee models for this.
But back to Einhorn: here the 11 billion dollars once under management have shrunk, through poor returns and the withdrawal of client money, to just 2.5 billion dollars. This cycle is typical: identifying talented fund managers in time is virtually impossible. Instead, investors are regularly lured in with historically good returns – ones that were achieved rather by chance. No sooner has the crowd invested than, alongside the absence of good luck, bad luck sets in and hands the majority of investors poor returns at high costs. Einhorn’s fund lost a total of 40% since 2012, whereas a simple index investment in the American S&P 500 would have achieved a return of plus 25%. Relative to the market, Einhorn has thus destroyed half of his investors’ assets.
Bets like those of George Soros may be of interest to historians, but as a model for successful investing they are of no use. We therefore want to close with a quote from the capital market researcher and Nobel laureate Eugene Fama, who sees it exactly the same way: „I can’t explain why anyone invests in actively managed strategies, and the question about hedge funds is merely an extreme version of precisely this question. Since I believe that all securities are correctly priced, my advice is to avoid high costs. So, forget about hedge funds.“
Sources for this article:
The rise and fall of John Paulson can be found here.
David Einhorn’s positions were reported here.
You can find the academic analysis of Bill Gross’ returns here, and a report on his „deep fall“ here.
