Tuesday, November 12, 2013

Compelling Investment Stories can be Dangerous

Compelling Investment Stories can be Dangerous

Although the biggest success stories in money management can make for interesting reading, they can also be very dangerous for investors.  This Sunday’s business section of The New York Times featured three institutional investors who made huge profits by making large investments in 2008.[1]  Bruce Karsh invested $6 billion in distressed debt through one of Oaktree Capital’s funds.  Jonathan Sokloff of Leonard Green & Partners invested $425 million from one of its funds in Whole Foods as the company’s stock spiraled downward.  Joshua Harris of Apollo Management acquired the debt of LyondellBasall, a large chemical company, for its investors at a deep discount.  Needless to say, all three managers made huge profits for their investors and themselves.  The article is built upon Warren Buffet’s aphorism to “Be fearful when others are greedy, and be greedy when others are fearful.”  The three vignettes are compelling, especially Mr. Harris’s use of the bankruptcy process to gain control of LyondellBasall and generate huge returns on Apollo’s investment.  However, these stories make contrarian investing look too easy.
Replacement (1999)
First, the story fails to mention all the other investors who thought they were making contrarian bets, only to find that they’d invested in disasters.  For example, TPG invested $1.35 billion in Washington Mutual in 2008, only to see the entire investment wiped out.[2]  In short, this story is very selective.

Second, Mssrs.  Karsch, Sokoloff, and Harris weren’t quite as courageous as depicted in the Times.  All three men and their senior colleagues were already very wealthy.  They were investing other people’s money.  So even if the investment didn’t work out, their fortunes and reputation were never at risk.

Third, all three managers had access to information that’s unavailable to the general public.  In addition, they had the ability to structure their investments to provide a level of downside protection.   Warren Buffet struck that type of deal when he invested in Goldman Sachs through a high yield convertible preferred.  The investment gave Goldman a vote of confidence from America’s savviest investor, Berkshire Hathaway got a high yield security, plus an opportunity to participate in Goldman’s recovery.   See “It’s Good To Be Warren Buffet: The Heinz Deal [February 15, 2013]” for a discussion of Mr. Buffet’s technique.  

Finally, it’s worth remembering that these kinds of opportunities don’t come around every day.  Every so often, the markets tank and courageous investors can follow Mr. Buffet’s aphorism.  However, this is not a useful investment strategy 99% of the time.  While the three stories from 2008 make for interesting reading, they can be very dangerous of investors thinking this is an easy path to riches.

[1] http://www.nytimes.com/2013/11/10/business/treasure-hunters-of-the-financial-crisis.html?ref=business&_r=0
[2] http://dealbook.nytimes.com/2008/09/26/tpg-watches-its-wamu-investment-vanish/

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