Lee Ainslie of Maverick Capital published his latest investor letter this week (big thanks to Marketfolly for finding it and distributing it) and it makes for some of the more interesting reading we’ve seen of late.
The whole thing is worth a read, but we thought a few points were particularly worth hitting in, especially this regarding the ease with which a fund manager’s long portfolio should be able to beat the market these days:
As large cap stocks outperformed in the late 90’s, the S&P 500 index consistently outperformed the
average constituent in the index – so finding shorts that underperformed the index was not particularly
challenging. In the current century (I use that term loosely, recognising that someone – probably my
father – will explain to me that technically the year 2000 was in the prior century), the reverse has been true. To the degree that the success or failure of short investments are judged by comparing results to the S&P 500 index, one needs to take into account this 14.2% annualized difference when bemoaning how much more difficult shorting has been recently compared to the late 90s. Of course, the flip side to this argument is that many managers (again, including Maverick) have probably spent too much time patting themselves on the back over their phenomenal long performance in recent years – not realising that even a random group of stocks would have been likely to outperform market-cap weighted indices since 2000.
This table from Ainslie breaks down the numbers:
Photo: Lee Ainslie, Maverick Capital
He also talks about hedge fund competition, and the myth of “crowded” trades that reduce profitability.
The concerns over hedge fund competition and crowded trades are perhaps even more
prevalent on the long-side. In contrast to short positions, long holdings in US companies are publicly
filed quarterly by money managers, which has allowed our quantitative team to study this issue
extensively. (This work started in support of our fund of funds effort.) We track the holdings of 120
large, fundamental long/short equity funds that collectively held $444 billion of US equities as of latest
filings. (Maverick represented less than $10 billion of this figure.) I believe both the degree and
impact of overlap is frequently misunderstood by both the press and investors. For instance, the stock
that is most commonly held by these funds is, no surprise, Apple Computer, which is owned by 59 of
these 120 funds. However, the cumulative holding of all these funds is only 2.6% of Apple’s shares
outstanding and only 1.5 days of volume.
Looking at the cross-ownership of Maverick’s portfolio and the portfolio of these funds, the
median number of firms that owns one of our US longs is 12, and for our US shorts the median
number is 9 – each a small fraction of the potential 119. Perhaps more importantly, the median
collective holding by this group of Maverick’s US longs is only 5.4 days of volume – a figure that
declines to 3.7 days if you exclude Maverick’s holdings. I think it is fair to assume that we would see
even lower levels of concentration among non-US securities, if such data were available to analyse.
In most investment strategies increased capital automatically leads to diminishing returns. As
more funds pursue a particular private equity investment, bidding becomes more frenzied raising the
entry price for the investment and lowering the eventual IRR. In arbitrage trades, virtually every
incremental dollar is invested in the exact same manner, so by definition spreads and returns shrink as
the capital invested in such strategies grows. Long/short equity is different as every new entrant and
every new incremental dollar depends upon human judgment (or upon algorithms driven by human
judgment) to determine how capital is invested. In other words, smart, sophisticated funds which we
respect may be long our shorts, or vice versa, at any time so increased competition does not
automatically reduce the spreads between the best and worst performing stocks.