Flight Of The Permabulls?

Legg Mason’s Bill Miller, famous for being permabullish during the entirety of the world’s largest bubble of all time (essentially his whole career, when he kept catching his one card straight draw on the river with bailout after Fed-engineered bailout over and over again), is finally calling it quits (Bloomberg):

Bill Miller, the Legg Mason Inc. (LM) manager famous for beating the Standard & Poor’s 500 Index for a record 15 years through 2005, will step down from his main fund after trailing the index for four of the past five years.

Miller, 61, will be succeeded by Sam Peters as manager of Legg Mason Capital Management Value Trust (LMVTX) on April 30, which is the 30-year anniversary of the fund, the Baltimore-based firm said today in an e-mailed statement. Miller will remain chairman of the Legg Mason Capital Management unit while Peters will be chief investment officer.

Miller, a value investor known for his bullish views of the economy and stock markets, became mired in the worst slump of his career as he wagered heavily on financial stocks during the 2008 credit crisis. Value Trust lost 55 percent that year as the S&P 500 dropped 37 percent, including dividends, prompting a wave of withdrawals. The fund’s assets have plunged from a peak of $21 billion in 2007 to $2.8 billion.

Bill Miller is a living example of selection bias at work. Notice what happens when his coin-flipping strategy of “heads” stops working.

We’ll likely see more announcements like this from other “top stock pickers” of the past few decades in the coming months and years. Good riddance!

Whitney Tilson’s Terrible, Horrible, No Good, Very Bad Investment

Whitney Tilson, famed value investor and manager of T2 Partners, has had a tumultuous and sordid affair with NFLX, a company he first failed to romance as a spectacular ever-rising short and which he now may very well fail to romance as a spectacular ever-cheapening long (Bloomberg):

Tilson had bet against Netflix from at least December, when he first wrote about shorting the stock, until February, when he disclosed to investors in a letter that he covered the short and was no longer confident that his investment thesis was correct. Tilson said he decided to buy shares today because he deemed them “cheap.”

“It’s been frustrating to see our original investment thesis validated, yet not profit from it,” Tilson, 44, said in a statement e-mailed from his New York hedge fund. “The core of our short thesis was always Netflix’s high valuation. In light of the stock’s collapse, we now think it’s cheap and today established a small long position. We hope it gets cheaper so we can add to it.”

Netflix plunged 35 percent to close at $77.37 in New York trading, its biggest drop since Oct. 15, 2004. The shares have declined 56 percent this year.

This is every investor’s worst nightmare and I am not calling attention to this to slander or heap ridicule on Tilson. Far from it– I don’t know if I’d have the cajones to go long a stock (at nearly 18x earnings) that I was previously trying earnestly to short.

That being said, let’s review this performance. If he started shorting in December he probably did it around $165-170/share. If he covered in February it was probably anywhere from $205-220/share. Let’s say $165/share short and $210/share cover. That’s a 27% loss.

The good news is the stock went as high as approximately $298/share, so he dodged that bullet. But then it plunged dramatically since then and is now trading at about $77/share. Assuming Tilson had just held his short (and kept making margins calls, or better yet, kept adding to it), he would’ve ultimately made a 53% gain!

What’s interesting about this? One, it would’ve taken Tilson nearly a year to be vindicated in his thesis. Value investors typically think of themselves as “long-haul” capital allocators. But in the world of shorting, time scales are compressed and a period like a year is more like a decade. A lot more seems to change. The moral of the story, perhaps, is to focus on shorts where you have identified an immediate, short-term catalyst that will cause the market to abandon its effort to push the stock higher. Simply recognizing a stock is overvalued doesn’t appear to be robust enough.

Two, investor psychology appears to be completely different between shorts and longs and with good reason. With a long, many value investors (like Tilson) invite the position to go against them, at least temporarily, rationalizing that this just makes it cheaper and easier for them to make money when their investment plays out. But with a short, where your potential loss is infinite, no investor ever has nor I assume ever will invite the position to go against them. Nobody ever says, “I hope the stock rises substantially from here because it just means another opportunity to short it more and make more money when it finally crashes.” Instead, many end up throwing in the towel, often at the worst possible moment.

Three, this episode demonstrates the need for humility. It’s possible Tilson will eventually make a good bet with his decision to go long NFLX. But if he doesn’t, he’s going to look doubly foolish, rather than singly. And, because he’s had a poor experience with this company once before, he risks making rash, emotional decisions about it in the future out of a subconscious effort to conquer his fear or slay the wild beast that marred him in battle once before.

If I was a big T2 investor, I’d be wanting to know what kind of safeguards Tilson and his team have put into place to prevent emotional bias from getting in the way of their analysis of NFLX going forward. And frankly, I’d have a hard time fighting my urge to tell Tilson to just leave the damn thing alone and reminding myself that I invest with him because I trust his judgment and if I were the expert I wouldn’t be paying him to manage part of my wealth.

The good news is Tilson is an experienced, grizzled value investor with an outstanding track record so even if he ends up totally boffing this one again it’ll likely be far from his undoing. For every potentially poor decision like this Tilson has demonstrated he can make many more superior ones and he doesn’t make the kind of levered, concentrated bets that could lead to a one-position wipeout that some of the less savvy figures like John Paulson have suffered in recent months.

Say what you will about value investors but one thing is for sure, they’re generally more prudent than the average bear, and I mean that metaphorically, not descriptively. Then again, this whole episode makes me wonder how Tilson defined his risk, then and now.