Why Investors Fail
I've been in the investment newsletter biz for nearly 20 years. I came in right after the Asian currency crisis and subsequent Russian default. I saw the Internet bubble grow and pop. I saw Greenspan attempt to buy his way out of a recession with debt. Then the housing bubble and crash...
Through it all, I've seen one recurring trait in the investors that manage to fail in spectacular ways: ego.
Bill Miller was once considered one of the best fund managers ever. His Legg Mason Capital Management Value Trust fund beat the market every year between 1991 and 2005. The odds of beating the market those 15 straight years were calculated to be one in 2.3 million.
Ironically, in 2006, Miller bought a yacht for $100 million. That marked the end of his winning streak.
The financial crisis was cruel to most investors. But it was something special for Miller.
On December 31, 2007, Miller's Value Trust owned 15 million shares of government-supported mortgage company Freddie Mac. At the time, he was happy to own Freddie Mac at a cost-basis of $34.07 because he felt the government would support the company.
By March 31, 2008, Miller had tripled his stake to 50 million shares, and they were trading at $25.32. A few months later, as the financial crisis really picked up steam following the Bear Stearns collapse, Freddie Mac shares had fallen to $8. And Miller's Value Trust owned 80 million of them.
He hadn't just doubled down on a losing position; he had quintupled down. And the results were not good.
The Wall Street Journal reported that Miller's Value Trust fund had $16.5 billion under management in 2007. By the end of 2008, it had assets of $4.3 billion, down 58% in one year.
Now, I don't know how well you remember 2008. A lot of big hitters got it wrong. I'll never forget Cramer assuring viewers that Bear Stearns was fine just days before it went under...
What Miller and others did during the financial crisis is known as "catching a falling knife." Nice image, right? Get it right, and it looks fabulous. Miss by just a little, and you get bloodied.
Humble investors don't try to catch falling knives. Because you're gonna miss at some point. One miss can ruin many, many successes. Miller's performance in 2008 dropped him to among the worst fund managers over a 10-year period. Pretty tough to make that up, as you need a 100% gain to offset a 50% loss. It's much better to wait for a stock to show signs of strength before buying.
The Ackman Effect
In the last couple of years, hedge fund manager Bill Ackman has been the poster child for ego-driven investing. First it was J.C. Penney (NYSE: JCP). He took a seat on the board, forced the CEO out, and brought in his own guy, who drove the company nearly to bankruptcy. Ackman finally took a $500 million loss, and JCP hasn't really recovered.
Of course, Ackman wasn't done. He took a $1 billion short position in Herbalife (NYSE: HLF) that he got soaked on. And he managed to lose $1 billion in a day on pharmaceutical company Valeant (NYSE: VRX). Last year, it was reported that Ackman's Pershing Square fund had lost around $3 billion total on Valeant.
Ackman has always been considered one of the smartest guys in the hedge fund industry. But this is what happens when you start to believe your own hype. You figure, "Well, I'm smart. I must be right, too."
But the stock market does not care if you are smart. It doesn't care if you "need" an investment to work out. It's been said before that the function of the stock market was to make as many investors look foolish as possible.
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Another One Bites the Dust...
Earlier this month, a British hedge fund guy named Crispin Odey was the most recent smart guy to go down in flames. His fund lost 50% in 2016, and he had a lot of blame to throw around.
He was one of the guys who said the Brexit vote was going to cause a recession in England and stocks there would get killed. And he was right... for about two days, when he was up around $400 million. He even bragged about it, saying: “This is a good day for me. I was brave. I had a lot of clients who were angry with me but they won’t be quite so angry this morning. Life is not about being un-brave at the right time. We in the City have certain skills.”
Certain skills. Yeah. Well, right after he said that, stocks started rallying. But Odey didn't give up. He watched that gain turn into a loss, a cardinal sin.
Odey blamed central bankers for keeping rates too low. And he even blamed index investing — which he called "mindless investing" — for his losses, saying, “Passive investing has taken money which typically would have been in the bond market and deposited it in the equity market..."
The one place Odey didn't put blame was on himself. Or on his ego, to be more specific.
Remember: the investment community represents many of the smartest people in the world. There are doctors focused on pharmaceutical stocks, Wharton MBAs analyzing retail stocks, former tech CEOs running venture capital firms, former Treasury Secretaries working at hedge funds...
It's just not realistic to think you're going to get ahead of these guys. But Ackman, Odey, and Miller made exactly that mistake. The stock market humbles everyone at one time or another. It also makes everyone feel like a genius, as in, "a bull market makes a genius of us all."
It's like they say in baseball: you're never as bad as you feel when struggling, and you're never as good as you feel when you're on a hot streak. Remember that investing is a grind, and you will be much more successful.
Until next time,
A 21-year veteran of the newsletter business, Briton Ryle is the editor of The Wealth Advisory income stock newsletter, with a focus on top-quality dividend growth stocks and REITs. Briton also manages the Real Income Trader advisory service, where his readers take regular cash payouts using a low-risk covered call option strategy. He is also the managing editor of the Wealth Daily e-letter. To learn more about Briton, click here.
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