Sunday, January 29, 2017

Review of Confidence Game: How Hedge Fund Manager Bill Ackman Called Wall Street's Bluff by Christine S. Richard

"A closed mouth gathers no foot." - Bill Ackman's high school yearbook

Confidence Game is the Bill Ackman equivalent of David Einhorn's Fooling Some of the People, except that Einhorn wrote his book and this one is written by a reporter who followed bond insurers and to whom Ackman gave full access to his notes and correspondence about this investment.

My conclusion about Einhorn's book was that going on a crusade against Allied Capital was a mistake for a number of reasons. In the very same ways, Ackman's crusade against MBIA seems like a mistake, even though he was right.

Life is too short to chase after the fraudulent stock shorts. The more crooked the management, the longer the fraud can last. As long as a company (whether fraudulent or just a bad business model) can attract investors fooled by some kind of Batesian mimicry it can persist.  But if a company is unprofitable and it owes more money than it can repay, the creditors can be the catalyst for the short.

The activist shortselling campaigns take a tremendous amount of time and also create a public commitment that is hard to modify or back down from if circumstances change. It seems like Einhorn has perhaps learned this lesson, but Ackman has not. His latest crusade, which seemed extremely misguided, was Herbalife. What if the distraction from the Herbalife campaign contributed to Ackman's debacle in Valeant?

Both Einhorn and Ackman had drawdowns in 2008. It's particularly amazing in Ackman's case because he was more right about MBIA than Einhorn was about Allied, and 2008 was the year that his trade paid off, and his credit default swaps that he bought for (as low as) tens of basis points per year were much higher returning (50x?) than Einhorn's Allied stock short.

As Alice Schroeder said at the time about Ackman's MBIA idea, "If the idea isn't strong enough to move the market, that's a sign its time has not come yet." When I wrote my review of the Einhorn book, a reader commented,
"Look at Ackman and Herbalife. (I think Hempton is right and Ackman is wrong, btw.) A gigantic, public position becomes something from which you can't back down."
An investment idea may be good, but not actionable. Too early means not actionable. I believe that there will be a bear market in U.S. bonds, but probably not yet. Remember the point that one astute investor made in Inside the House of Money:
"A really important lesson in investing is that being either too far in front or too far behind is when you get hurt, whereas being right at the edge of the wave is where the money is made."
Another good point from the same book, from Scott Bessent, who left Chanos to work for Soros in 1991:
"[Y]ou don't have to be skeptical about everything. Maybe the guys at Starbucks really are good managers and it really is one of the greatest concepts ever. Maybe eBay is the perfect business model. Short sellers can't think that way."
I wonder whether Ackman will survive the next bear market? Also, questions for audience: is it possible to be a good investor and not be humble? Is it possible to survive for 50 years as a professional investor and not be humble?



CP said...

The purpose of muni bond issuing authorities:
"The issuance of these bonds didn't require a vote by local [tax]payers because the municipality was not pledging its full faith and credit."

Why do muni bonds need "insurance"?:
"Moody's overrates MBIA and massively underrates municipals, thus generating this huge business of bond insurance... The ultimate irony is that the triple-A-rated bond insuraners, who are rated on the corporate scale, are in fact riskier than the A-rated muni issuers, who are rated on the muni scale but are much less likely to default than the insurers."

CP said...

January 30, 2008

"The problem with these insurers is the correlated risks. The same event - a huge decrease in real estate prices - is going to cause unusually high numbers of simultaneous, unusually high claims."

CP said...

Ackman and Einhorn and their MBIA/AlliedCap shorts are an example of not being able to see the forest for the trees.

Why couldn't Ackman look beyone the single exemplar of MBIA to think about what was happening with the entire financial system? He knew that Moody's was rating hundreds of billions of dollars of debt too highly. His answer was to continually badger them. How about looking at all of the highly leveraged banks that were buying the paper? As far as I can tell, that didn't cross his mind.

James said...

It's particularly amazing in Ackman's case because he was more right about MBIA than Einhorn was about Allied

How was he right? His 2003 presentation is still online; it barely mentions subprime mortgages. He shorted MBIA for a bunch of dumb reasons, stubbornly stuck with it for years after his bear raid had failed and he was clearly wrong, then lucked out when it blew up for a totally different reason.

ADL said...

Very interesting question re: humbleness. I think professional trading, with its adages dating back to Livermore and before, is a discipline based on humbleness: you never fight the market, and the market will tell you whether you're right or wrong, never the other way round. Investors like to see themselves taking the opposite side of traders (and oh the slippery slops surrounding this distinction!) and so I think there's an inborn urge against humbleness: if you see something nobody else does and the trade goes against you, well, that's just more confirmation of a consensus against which you can ramp your position.

Paradoxically, this may work more on longs, and especially well-regarded longs, than shorts: in a short there's usually at least some fire to go with the smoke (side note: is Tesla ever going to back this up?), so you at least get an anchor on stock appreciation. But with VRX, the great sin was having a variant perception that was basically agreeing with the market, only more so--basically, thinking like a trader but believing oneself to be an investor.

For all he's (rightfully?) knocked, I think Buffett understands this distinction, and that one can (and, to be a good investor AND trader) be both bold and humble. I think a lot of investors think these two are mutually exclusive. It comes down to lack of specific types of fear: not being afraid of looking wrong (hard), and not being afraid of being wrong (extra hard).

ADL said...

A misspelled/missing word or two, but you get the gist...

Anonymous said...

After the book came out, to modest sales, Richard left journalism and joined Indago Group, a small research firm that catered to hedge-fund investors. It had been successful developing short-selling ideas in the for-profit education sector, where low-income students took out government-backed loans to earn largely worthless degrees—leading to a high default rate. Now Richard was charged with finding another industry that had been allowed to inflate into a fraudulent, and presumably fragile, bubble. She started researching Herbalife. “Just looking at it, I vaguely felt that it was a fraud,” she said. “I remember thinking, If someone smart were to just call it out, someone who had the ear of the market, it would collapse.”

She called Ackman. “Bill,” she told him, “I think I found your next M.B.I.A.” It looked to her like a billion-dollar idea.