Posted: 31 December 2020
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Learning from the best
Ahead of the new year, I seek to understand what selected hedge fund managers have been up to recently, how they have performed over 2020 and how they are positioning themselves going into 2021.
With the S&P 500, Dow, and even Bitcoin, hitting all-time highs, 2020 has proven to be a rather eventful and surprising year. While over 5.1 million shots of Covid-19 vaccine has been administered in 22 countries worldwide, we are just seeing the rise of a new and more contagious strain of the SaR-CoV-2 (the coronavirus that causes Covid-19), the B.1.1.7 strain. The B117 strain is said to be 70% more transmissible than other circulating strains with almost two dozen mutations, which may affect proteins made by the coronavirus, and hence, may diminish the effect of existing vaccines (unproven). Originating in the UK, the new strain has now found its way to the U.S., Singapore, Australia, Netherlands, Denmark, Germany, Switzerland, France, Spain, Sweden, Japan and Canada.
As we enter the new year with increased uncertainty over where this global pandemic will lead us, I hope to understand what the top investors are doing to protect themselves from such risks.
Investor 1: Ray Dalio (Bridgewater Associates)
Diversify, diversify, diversify – Ray’s core investing principle revolves around diversifying with 15 – 20 highly uncorrelated return streams. His research has led him to what he calls "The Holy Grail" [of investing], where a well-diversified portfolio will significantly reduce the chance of an investor losing money. Ray believes that diversification is key as investors, even the most experienced ones, are bound to have blindspots.
Bridgewater Associates adopts a global macro strategy -- i.e. it bases its holdings primarily on the overall economic and political views of various countries or their macroeconomic principles. Funds with this strategy typically benefit from increased market volatility.
Bridgewater Associates’ Performance in 2020
Bridgewater’s flagship fund, Pure Alpha II fund, has lost 18.6% after repositioning its portfolio for an rising market at the start of the year (ahead of unexpected Black Swan event). Reportedly, at least one investor has withdrawn funds in 2020.
Ray Dalio’s Outlook on 2021 and Beyond
Over the course of 2020, Ray and Bridgewater Associates have dedicated their time and efforts to put together a masterpiece, The Changing World Order. Throughout his life, Ray has found that the things that surprised him has often happened many times in history, but just not in his lifetime. This formed the basis for his new book which studies the rise and fall of past leading empires.
At the crux of it, the book discusses the cycles of money, credit, debt and economic activities, and also how the world’s power/influence is slowly shifting. In essence, prior to the USD being the reserve currency and the “US empire” as we now live in, there were the British empire (1750 – 1900s A.D.), the Dutch empire (1600s – 1750s A.D.), and the Chinese empire (1500s – 1600s A.D.). He found that empires typically lasted for 100 to 150 years, and that the high levels of debt, extremely low interest rates, large wealth gaps, political and social division, as well as the rising of another superpower (China) are threatening the overextended power of the US.
(Suggested video: How the Economic Machine Works by Ray Dalio)
Ray Dalio’s Advice
- Dollar as a reserve currency is under threat (due to an overextension of stimulus — debt production and monetization)
- Favour stock and gold over bonds and cash (USD) — ultimately a bond is a promise to deliver currency (fiat)
- Ray acknowledges that Bitcoin and some other cryptocurrencies have established themselves to be gold-like, limited-supply mobile store holds of wealth, but prefers to hold things that central banks will want to hold and transact in.
- Ray has for a long time held a high regard for China and its rise — warns people not to ignore it.
- Diversify well in terms of currencies, countries and asset classes
Deepest condolences to Ray Dalio and his family for the lost of their 42-year-old son, Devon Dalio.
Investor 2: Bill Ackman (Pershing Square Capital)
William Albert Ackman (or Bill Ackman) is an American investor and hedge fund manager. He founded and runs Pershing Square Capital Management. Considered by some to be a contrarian investor, he often considers himself as an activist investor, with his most famous (nor notorious) fight being with Carl Icahn over Herbalife. (See this post for more information)
Bill often focuses on mid- to large-cap companies with no control, low financial leverage (debt) and with room for value creation (growth or optimization). As an activist investor, he buys shares in public companies, pushes for changes and allows the market to realize the intrinsic value of these companies.
Ackman owns a concentrated portfolio of about 10 assets as he believes that diversification is protection against ignorance, and never invests in a company without proper intensive due diligence.
Pershing Square Capital’s Performance in 2020
In 2020, Ackman’s Pershing Square Capital has earned a net return of ~47%, with its share price being up 77% YTD. This year, Ackman was perhaps best known for his hedging bet on credit default swaps (CDSs) which turned $27 million into $2.6 billion. Following which, in July 2020, Ackman to raise US$4 billion in the IPO of Pershing Square Tontine Holdings, a Special Purpose Acquisition Corporation (SPAC).
How it works
Think of CDS as an insurance on defaults or a credit event: The protection seller receives a fixed payment (called "CDS premium" or "CDS spread") from the protection buyer to provide protection against a default or credit event. In the event of a credit event (a trigger), the swap contract terminates and the seller pays out to the buyer. If nothing happens for the tenor (length) of the contract, the buyer will just pay the spread over the tenor of the contract to the seller.
A Credit Event is a trigger that causes the buyer of protection to terminate and settle the contract. Credit events are agreed upon when the trade is entered into and are part of the contract. (E.g. bankruptcy, failure to pay, restructuring, obligation acceleration, obligation default, repudiation/moratorium, government intervention)
What is Credit Risk?
Credit risk is the possibility of a loss resulting from a borrower's failure to repay a loan or meet contractual obligations. Imagine someone tries to borrow $1,000 from you, you will naturally hesitate because of credit risk!
Types of CDSs
- Single-name CDS: allows for the transfer of credit risk associate with a single entity.
- Multiname CDSs: Payoffs are made contingent on one or more credit events affecting two or more reference entities. CDSs on baskets of credit risk offer specified payouts based on specified numbers of defaults in the underlying credit risks. E.g. In a First-to-Default CDS, the protection seller compensates the buyer for losses associated with the first entity in the basket to default, and thereafter the swap terminates and provides no further protection.
Methods of Settlement
CDSs can either be settled in physical form (delivery of a bond to the seller of protection) or in cash.
Uses of CDSs
- Hedging: To act as an "insurance" in an event of default (EoD) or credit event. Allows the buyer of CDS to transfer default risk to the seller of CDS, just like how personal insurance transfers the risk of being in an accident to an insurer.
- Speculation: To bet on an impending default or credit event.
- Market linking: The highly liquid credit derivatives serve as a source of information -- as CDS market often reacts before relatively less liquid markets like bond/loan markets. CDS spreads often move in advance of bond spread movements as investors seek to maintain the value relationship between bonds and CDSs.
A SPAC, often known as a Blank-Cheque Company, is a corporation (SPV) that is incorporated with the aim of raising funds to acquire another company. In a SPAC IPO, shares of the SPAC (an empty shell) are sold to investors with the promise that an acquisition will be made in 18-24 months' time.
It is known as a blank-cheque company as investors are effectively signing on a blank-cheque and allowing the management of the SPAC to "freely" acquire as they see fit.
Bill Ackman’s Outlook on 2021
The Covid-19 outbreak has affected businesses in a disproportionate manner, where the bigger ones can adapt, survive and even come out of the crisis stronger, while the smaller/less-capitalized ones fold. Ackman believes that the markets is set up for a very strong recovery in 2021 but the virus news will remain the “big negative news in the short-term”.
That said, Ackman seems to be expecting waves of corporate defaults as he moved to place a large bet against corporate credit in November 2020.
He also remains pessimistic in the near-term, citing that the financial markets is underestimating the impact of the pandemic. In his tweet, he even urged President Donald Trump to shut down the country for the next 30 days and to close borders, sparking a momentary sell-off in the markets.
Ackman’s Advice
- TINA (There is No Alternative to equities) — Ackman is not fond of buying bonds due to (1) low yield, (2) no potential for upside and (3) a long lock-in period.
- Invest in high-quality, market-leading companies, which you will be comfortable owning even if you were to be shut off from the markets for 10 years
Investor 3: Cathie Wood (ARK Invest)
Cathie Wood is the CEO and CIO of Ark Invest. Cathie is a thematic investor who is focused on technologically enabled disruption that cuts across economic sectors. She believes in the efficient allocation of capital which has led her to adopt an ETF structure for her funds, making them more accessible to retail investors.
Cathie Wood's investment style is deeply rooted in disruptive technologies. She holds a firm belief that over the long term, this investment strategy delivers returns well above broad-based investment benchmark. Ark Invest runs 7 different ETFs focusing on themes like:
- Technological Innovation,
- Autonomous Technology and Robotics,
- Next Generation Internet,
- Genomics,
- Fintech, and
- 3D Printing
Cathie uses social media to gain an edge. Unlike typical investment banking number crunchers, Ark analysts make connections with industry experts and researches to get deep insights.
ARK Invest’s Performance in 2020
All of ARK Invest’s five actively managed ETFs (ARKK, ARKG, ARKQ, ARKW, ARKF) have at least doubled in 2020. Cathie Wood has been gaining increasing recognition ever since she was ridiculed for ascribing a US$4,000 target price to Tesla back in 2018 (when it was only about US$250, or US$50 post-stock-split in 2020). Since then, Tesla has skyrocketed to as high as US$695 post-stock-split (or ~US$3.5k pre-stock-split).
Cathie Wood’s Outlook on 2021
As you can gather by now, Cathie Wood believes in three things — innovation, innovation, and innovation. Although it seems she has developed a cultish following, she is in fact an extremely savvy and witty investor who has a strong grasp of financial and economic concepts. Every month, Cathie posts a podcast on the Ark Invest Youtube Channel to inform investors of what has been happening and what is to come. Below is a quick summary on Cathie’s outlook:
- High savings rates means that consumers still have firepower
- Copper has broken out (increased tremendously) in the absolute sense and has broken out in relation to gold. One of the big reasons is that the USD is breaking down. This may help to bolster earnings (I assume she means currency translation gains for corporations)
- If the 10-year Treasury yield was to move above 100bps (or 1%), this will be troublesome for fixed income investors, but less so for equity investors as Cathie believes that the rotation from fixed-income to equity is long overdue. She cites that the equity market saw a net outflow of US$400 billion while the fixed income market saw a net inflow of US$800 billion this year, which translates to a US$1.2 trillion difference. Hence, she maintains that the equity market is not a bubble until this relationship flips.
- Equity market correction is in due order — Market indicators like the bull-bear ratios or the American Academy of Individual Investors (AAII) indicators are up to very high levels. Often, when these indicators have high positive readings, we tend to get a correction.
Cathie’s Advice
- Cathie calls indexes the biggest form of misallocation of capital in history, which has led to the tracking of performance of older firms and the ignoring of the truly emerging tech.
- Corporates are starting to pour into Bitcoin (e.g. PayPal Launches New Service Enabling Users to Buy, Hold and Sell Cryptocurrency, Square, Inc. Invests $50 Million in Bitcoin, Robinhood). Cathie believes that BTC can reach a value of US$400k – 500k [Cathie Wood allocated ~7% of a private fund to Bitcoin]
- Cathie expects genomics sector will deliver an annualized return of 20% p.a. over the next 5 years.
Investor 4: Ari Bergmann (Penso Advisors)
Ari Bergmann is the Founder and CIO of Penso. He created some of the first derivatives while at Bankers Trust in the 1990s. Later, he moved to work in the precious metals and commodity trading before becoming the CEO of Sentinel Advisors, managing the Citadel Master Fund (derivatives arbitrage) and the Symphony FOHF (multi-manager fund of hedge funds).
Penso focuses on derivatives, macro-strategies and convexity. Its investment strategy is to find opportunities with convexity, i.e. a limited downside and a leveraged upside.
Bergmann seeks to create portfolios that will benefit a lot on a leveraged basis if the market falls, but will at least breakeven if the market goes higher.
A rather foreign concept to retail investors like us, tail-risk hedging refers to "buying insurance" / hedging on high-impact and low probability events that are unforeseen/surprising.
To be specific, tail-risk refers to a form of portfolio risk that arises when the probability that an investment will move more than 3 standard deviations from the mean is greater than what is shown by a normal distribution.
Penso Capital’s Performance in 2020
Tail-risk hedge funds have rolled in the big bucks in 2020 after a once-in-a-lifetime Black Swan event. If Penso Capital was anything like its peers, returns this year could range anywhere from 100% to 4000%. Unfortunately, I was unable to find any information on this.
Ari Bergmann’s Outlook on 2021
On the proactive hedging books, Bergmann is worried about a couple of things (Source: Octavian Report):
- Uncertainty on the future economic relationship between China and the rest of the world. Bergmann fears the second-order consequences of the tension — i.e. people that depend on China for trade (countries, economies which are commodity-based, Asian currencies which depend on exports to China). China’s shift from an infrastructure-building economy to a consumer economy will hurt economies exporting commodities to China.
- Geopolitical Risks: Bergmann is concerned that the instability in the Middle East (primarily Syria, Iraq and ISIS) will spill over into Europe and create stains on the EU. Adding such strains on top of economic imbalances within the euro zone will no doubt escalate tensions.
- Shift in U.S. Monetary Policy: Near-zero interest rates are unsustainable. However, he notes that if the Fed tightens and the market can stand it, the market can have a rally on that since it is a liquidity-driven market. As such, investors should keep a close eye on how the markets react to an eventual tightening of the MP.
- Agnostic on precious metals (holds no opinion) and questions the buying of gold as a hedge as interest rates eventually risk (higher opportunity cost).
- Bergmann is not fond of people buying gold following the printing of money (quantitative easing) as he sees no merit in holding something with the only source of safety coming from scarcity.
- Market is too complacent and over-reliant on central banks: The market is too used to the world as it is and becoming over-reliant on central banks providing liquidity and allowing asset markets to rise just by creating mega-liquidity, making it very dangerous.
Investor 5: Mark Spitznagel (Universa Investments)
Mark Spitznagel is an American investor. He is the President and CIO of Universa Investments LP, a tail-risk hedge fund. After starting his career as a futures trader, he went on to partner with Nassim Taleb, author of the Black Swan, to start a fund called Empirica Capital in 1999. In 2007, he founded Universa on his own with the purpose of performing capably during periods fo market stability but vastly outperform during financial crises.
Unlike Ari, Mark Spitznagel sees this tail-risk investment strategy as an insurance against systematic stock market crashes and crises in general. In essence, Universa tries to make astronomical returns through risk mitigation.
Alongside his team of PhD's, mathematicians and traders, they earn their money by making trades that almost always lose small sums, but rarely generate astronomical payouts. Universa buys short-term options contracts that protect against a spike in volatility, or plunge in markets, which are highly "convex" and "out-of-the-money". Essentially, these trades payoff when there is a sudden massive crash.
Every trading day, investors around the world make a little easy money by selling Spitznagel options. Until one day–maybe only every five or ten years–a black swan appears, e.g. terrorists ram jets into skyscrapers or a global pandemic freezes the global economy. Then the tables turn hard and Spitznagel makes an enormous amount of money.
Universa’s Performance in 2020
Spitznagel is keenly focused on feeding off the greed of traders, who prioritized quick gains over prudent risk taking. They readily assume tail risks (huge, but extremely remote potential losses) to earn easy gains. In March, Forbes estimated that Spitznagel’s protection trades cost under US$100m to put on and yielded at least $3 billion for Universa’s clients.
Key takeaways from Mark Spitznagel on investing
- All that matters is you’ve got to take your small losses — Mark believes in paying small dues in times of stability to reap outsized rewards during volatile times.
- When people think that the markets are cheap right now, they are just kidding themselves.
- Sell immediate gratification for a massive payday far down the road — Forbes liken this ot how Buffett accumulates cash from small insurance premiums over long periods, building dry powder, that he can use to pounce on bargain buys.
- Spitznagel is certain that his moat will go away eventually, but herd mentality in Finance will help to slow this.
Now for everyone's favourite mogul
Investor 6: Warren Buffett (Berkshire Hathaway)
Known as the "Oracle of Omaha", Warren Buffett is perhaps the best known, and most successful, investor to everyone. He is a self-made billionaire who hustled hard in his formative years doing door-to-door sales before he started investing. He bought his first stock at age 11 and first filed taxes at age 13. Buffett is the Chairman and CEO of Berkshire Hathaway.
In his early years of investing, Buffett focused heavily on "Cigar Bud companies", i.e. fair companies that were at a deep discount to their intrinsic value.
Later, when he joined Berkshire Hathaway, his investing philosophy shifted towards "buying quality companies at fair price". At the core of his investment style lies five fundamental rules:
- Buy and hold: "our favourite holding period is forever" "In the short run, the market is a voting machine but in the long run it is a weighing machine"
- Never invest in a business you cannot understand.
- Buy companies with a large margin of safety
- Invest in companies with a moat
- Time in the market, is better than timing the market.
Berkshire Hathaway’s Performance in 2020
Berkshire Hathaway stock has lagged the S&P 500 since late 2018 and its lacklustre 0.7% return is showing of this. Famously quoted as the investor to say “be greedy when others are fearful, and fearful when others are greedy”, Buffett and Berkshire Hathaway had pretty much been sitting on cash pile when the markets fell in March. Furthermore, Berkshire went on to sell and take losses by exiting large positions in four U.S. airlines, as he thought that the airlines industry was no longer as profitable.
After facing fierce criticism for not deploying dry powder, Berkshire Hathaway has spent US$18b on equities (Bank of America, Snowflake, Abbvie, Bristol Myers Squibb, Merck, Pfizer), US$9b on share buyback and US$10b on the acquisition of Dominion Energy’s natural gas assets and the energy group’s debt.
Warren Buffett’s Recent Moves
After facing fierce criticism for not deploying dry powder, Berkshire Hathaway has spent US$18b on equities (Bank of America, Snowflake, Abbvie, Bristol Myers Squibb, Merck, Pfizer), US$9b on share buyback and US$10b on the acquisition of Dominion Energy’s natural gas assets and the energy group’s debt.
While many commentaries have surfaced of late about Buffett fearing a market crash, most are based on inference and were not directly from the horse’s mouth. Regardless, here are some interesting points that several commentaries have picked up on:
- Buffett’s indicator of an impending market crash (sum of market cap of all listed companies divided by the GDP) is moving.
- Buffett/Berkshire seems to be building towards an “elephant-sized” acquisition (just as they have done with IBM and Philips). Keep
Unfortunately, there seems to be a lack of information on this topic. But one thing is clear — Buffett does not approve of bitcoin!
Personally, I am leaning towards taking advantage of the recent dip to invest in ETFs like ARKG, ARKK and/or PRNT. I am also thinking of putting a small % of my net worth into Bitcoin as a long-term bet / diversification. However, seeing how Ripple (XRP) was recently crushed by an SEC lawsuit really echoes Ray Dalio’s preference towards holding something that the central banks will hold/transact in.
Let me know in the comment section below if there are other interesting money managers that are worth following! And if you liked what you read, please subscribe to our newsletter below to get updates on our latest posts.
Thanks for reading and happy new year to all readers! 🙂
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