Monday, January 5, 2015

Worse Than Just Crowded Trades: Investing "Anti-Strategies"

I wrote recently that "There are no evergreen investment strategies that will always work."

That may sound like an obvious statement, but I would strongly argue that many investors are blithely implementing strategies that are so crowded and tired that they should now be considered "anti-strategies."

The two examples I have thought of recently are spinoffs and merger-arb. This year the two really good spinoff plays were shorts; both comically obvious "garbage barge" just-in-time dumpings of obsolete assets: CVEO and PGN. Similarly, the rare opportunity to make worthwhile money in merger arb would be to look for the deals that are going to break.

My point is that: Many shall fall that are now in honor, and many shall be restored that are now fallen. Looking at the "ecosystem" of investment managers, what you would expect to happen is for the fat, old, lazy managers who are coasting on something novel that they did decades ago to rotate out of the business after some shock to the system. (Equity crash with interest rates staying low would be one scenario.)

A correspondent contributes:

I've been meaning to do a post on activist investing. I think it qualifies as another anti-strategy. In addition to being overcrowded, it has a few issues that make it inherently likely to fail:

1. Most of the activists are bean-counters with little or no operating experience. They can claim that a company is being mismanaged, and they may be right, but that doesn't mean they have the skills they would need to manage it better.

2. This is speculative, and I haven't seen any studies that verify this, but my impression is that activism becomes more common as valuations rise and it gets later in the economic cycle. When a bull market is in its infancy, there's less need for activism because stocks are cheap enough to deliver strong returns without any governance changes. Once valuations have risen and multiple expansion is off the table, investors need to see cost cuts, governance changes, or something similar to justify further appreciation. There is a "squeezing blood from a turnip" aspect to activism.

3. As a result of 1 and 2, most activist campaigns are gimmicky: calling for spinoffs, issuing debt to buy back stock, or other actions that are designed to juice the stock price but don't improve risk-adjusted returns.

Between the spinoff and the activist campaigns, CVEO is like an anti-strategy singularity. Along with POST, I think people will look back at it as the canary in the coal mine for popular HF strategies. I'm not really familiar with merger arb but I saw your review of Guy Wyser-Pratte's book. Joel Greenblatt wrote about merger arb getting too crowded in the late '90s, and I imagine it's only gotten worse since then.
The review of Risk Arbitrage by Guy Wyser-Pratte is here.


bjdubbs said...

Spinoffs still represent an opportunity, but not immediately on the spinoff. Wait for the post-spinoff puke. Maybe SHOS or CVEO or PGN aren't great buys here, but at some point they'll be good buys. The opportunity isn't so much in the spinoff as in the stampede to sell by the 100% of holders sitting on a loss.

James said...

Maybe SHOS or CVEO or PGN aren't great buys here, but at some point they'll be good buys.

There isn't any price where I would consider PGN equity a good buy unless they're paying you to take the shares.

bjdubbs said...

Didn't look closely at PGN. Yeah, it has some problems . . .

Steve said...

My nominees:

Spinoff: SSE

Activist: HTZ