If we see higher risk assets further over-valued, do not chase the move, but rather sell into price ...
No Guru Is Too Big to Fail
10/20/2011 10:42 am EST
The story of two of the biggest names in investing shows that even wildly successful experts are profiting on borrowed time, writes MoneyShow.com editor-at-large Howard R. Gold.
The market has been pretty rough these days for all of us. But some big-name investors are probably doing worse than you are.
William H. Gross, the head of Pimco Total Return Fund (PTTAX) and the most illustrious bond investor of our time, is reeling from a big move out of US Treasuries early in the year.
John Paulson, he of the “Greatest Trade Ever,” is anxiously awaiting the end of the month, when he’ll see how many of his investors cash out of his Advantage hedge funds after heavy losses this year.
Both Gross and Paulson are big names who’ve had rough patches, and their experience shows how tough it is for even the best to beat the market consistently over long periods—especially if managers make big macro bets on the economy or stray beyond their areas of expertise. (Paulson’s spokesperson declined my request for comment, and Pimco didn’t respond by deadline.)
Bill Gross has presided over Pimco Total Return for nearly 25 years. During that time, he built it into the US’s biggest bond fund, with $242.2 billion in assets as of September 30. Forbes estimates his net worth at $2.2 billion.
Gross has fame as well as fortune, appearing regularly on CNBC, where he is lionized, as well as in the venerable Barron’s Roundtable. He’s also well known for his clever commentaries, which are posted monthly on Pimco’s Web site.
In his March missive, Gross explained his big call for this year: He was dumping Treasuries, because of what could happen once the Federal Reserve ended its latest round of quantitative easing (QEII).
“Who will buy Treasuries when the Fed doesn’t?” he wrote. “Yields may have to go higher, maybe even much higher, to attract buying interest.”
It seemed plausible at the time. But when the economy weakened and the European debt crisis flared up again, investors did what they did in 2008—they rushed for the safety of US Treasuries. Amazingly, that occurred even after Standard & Poor’s cut the US’s AAA rating in August.
- Read Howard’s column in which Gary Shilling predicts a new recession and favors Treasuries.
The flight-to-safety rally drove the yield on the ten-year Treasury note down to a 65-year low of 1.72% on October 4, from around 3.5% in early March—a humongous move, which Pimco shareholders missed. Pimco Total Return, which has beaten its benchmark over every time period since its inception, has been near the bottom of its peer group over the past year.
Gross admitted to losing sleep over it, and finally, predictably, he threw in the towel. In a piece entitled “Mea Culpa,” Gross wrote: “This year is a stinker. PIMCO’s centerfielder has lost a few fly balls in the sun.”
“As Europe’s crisis and the US debt-ceiling debacle turned developed economies towards a potential recession, the Total Return Fund had too little risk off and too much risk on,” he continued.
But now, having been too optimistic about the economy, Gross seems to be going to the other extreme. Pimco started loading up on long-duration Treasuries late this summer, anticipating that the Fed’s Operation Twist would gobble up 30-year T-bonds.
We’ll see if he’s right, but I wonder whether this kind of all-or-nothing bet is really beneficial to investors. Actually I don’t wonder, but I’ll get to that later.
And while we’re talking about macro bets, consider John Paulson. Having started Paulson & Co. with $2 million in 1994, he was little-known until he scored big by shorting subprime mortgages as the housing market crashed.
His funds were up $15 billion in 2007, and he made more than $3 billion personally that year—“believed to be the largest one-year payday in Wall Street history,” The Wall Street Journal wrote.
NEXT: No Greatest Trade Ever This Year|pagebreak|
Paulson & Co., you may recall, was the firm for which Goldman Sachs (GS) set up its notorious ABACUS collateralized debt obligation (CDO), which allowed him to short handpicked subprime mortgages. Paulson was never accused of wrongdoing by either the Securities and Exchange Commission or the Senate committee that investigated the deals.
- Watch Howard’s video on Goldman Sachs and George Orwell.
But in the past year, Paulson has stumbled badly. Though he’s done well until recently with his big investment in gold, through the SPDR Gold Shares ETF (GLD, in which I own a much smaller position than he does), he also loaded up on shares in banks like Citigroup (C) and Bank of America (BAC). Bank stocks, of course, have been a disaster as the economy weakened.
He also lost $750 million on Sino-Forest, a Toronto-listed Chinese timber company caught up in an accounting scandal.
Result: His Advantage Plus fund was down 47% as of this month, and his Advantage funds have lost a third of their value, or $6 billion, since the beginning of the year, according to The New York Times’ Deal Book. Paulson is bracing for big redemptions at the end of the month.
“We made a mistake,” he reportedly told investors on a conference call. And he is moving to reduce leverage—another swing in the opposite direction.
Well, at least both billionaires have admitted their errors, which is refreshingly candid on Wall Street...though Paulson also took the opportunity to lecture the Occupy Wall Street protesters, who don’t have enough money to lose half of it in the market in a year.
But both men went all in on huge macro bets on the economy. It speaks to overconfidence, even hubris—not surprising when everybody around you calls you a genius all the time.
“People who are entrepreneurs and money managers...tend to be overconfident in their abilities. When they fail...you generally don’t know about it,” said Meir Statman, a finance professor at Santa Clara University and one of the leading lights of behavioral finance.
He has written a book, What Investors Really Want, which explains behavioral finance’s key concepts clearly, with down-to-earth examples.
Statman believes even fund managers with great track records are living on borrowed time. “They have skill and they have luck,” he told me. “There are some periods when luck combines with skill and they wind up looking infallible.” That’s usually around when they crash and burn.
But Statman actually believes most of their performance is due to luck. “I find myself amazed that those people, knowing what they should know—that most of it is luck—can go on TV and say the market is going to go up or go down. It is supreme overconfidence,” he told me.
I think skill plays a bigger role in it than Professor Statman does, but anybody—no matter how good their track record—who tries to outguess the markets in a shaky economy like this one is asking for trouble.
Those unhedged macro bets, which both Gross and Paulson made, produce plenty of alpha—excess return— when they’re right, and plenty of pain when they’re wrong. That’s why for us mere mortals, diversification is the only way to go, and we should make our “bets” with only what we can afford to lose.
“People expect that gurus are going to be right all the time,” said Statman. “They jump from guru to guru, but there are no gurus.”
No, there aren’t, and even the gurus themselves are beginning to find that out.
Howard R. Gold is editor at large for MoneyShow.com and a columnist for MarketWatch. You can follow him on Twitter @howardrgold, read more commentary on www.howardrgold.com, and check out his political blog at www.independentagenda.com.
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