Who would have expected a superstar of the financial crisis, with a return of 212% in 2007, to have trouble making mid-single-digits since then?
Kyle Bass (Trades, Portfolio), a Texan hedge fund manager, has made some interesting bets over the past decade, but none have revived the old magic.
What is it about his global shorting strategy that has gone wrong?
Who is Bass?
Born in Miami, Florida, Texas-based D Magazine says Bass moved to Dallas as a child.
His investment career began at Bear Stearns, in the field of event-driven special situations and short selling. He was promoted to senior managing director at age 28 before moving to Legg Mason. At the latter firm, for which he managed the Dallas office, he closely watched the housing industry. While in these two jobs, he saved enough to start Hayman Capital Management in 2006.
After months of research by Bass and his team, they were ready to take on the then-burgeoning subprime mortgages industry. He short sold some $4 billion worth of subprime securities to the synthetic Credit Default Swap market.
Bass' research and intuition proved correct, and an initial $110 million investment became a $700 million jackpot. That, in turn, led to a highly publicized appearance before an investigative committee in Washington D.C., where he provided a much-quoted analysis of the meltdown.
What is Hayman Capital?
Hayman Capital Management L.P., is a Dallas-based investment management firm that provides services to private pooled vehicles and separate accounts. It is solely owned by Bass.
According to the Form ADV Part 2A, its investors are typically institutions, funds-of-funds, family offices and high-net-worth individuals.
This firm is an umbrella organization for numerous other Bass-owned entities, including a Cayman Islands exempted company. These entities manage private funds, including the Hayman Funds, the China funds and the Hong Kong funds.
In a Form ADV filing on June 5, 2017, the firm reported $815 million of discretionary assets under management. On Jan. 16, 2017, $63 million, or less than 10%, was in equities.
Strategy
Hayman invests in three types of opportunities:
- Macroeconomic trends.
- Special situations.
- Event-driven situations.
It does not invest in real estate, perhaps appropriate for a fund manager who made his name by shorting the housing industry.
They report the investment process starts with idea generation. Team members monitor a defined universe of sovereign actions, corporate events, global market conditions and internal and external sources.
Then, the successful idea is evaluated on intrinsic value and on its risk and reward profile.
Once past this hurdle, remaining ideas are subject to fundamental analysis of the economics involved, pricing discrepancies and identified catalysts. At this stage, they also assess country risks such as government, gross domestic product, capital account, political stability and currency.
As noted, Bass became a star investor by recognizing and profiting from the subprime mortgage crisis. Since 2008, he has also made several other, seemingly brash, bets:
- Drug prices: This shorting campaign began in 2015, as Bass saw an opportunity to challenge drug patents, drive down the cost to consumers and make a profit for his firm. He had mixed success, and apparently little financial success. Business Insider reported in February 2016 that Bass had given back most of the $700 million he had raised from investors. It also reports Bass intends to keep fighting the patents.
- China: Bass was convinced the Chinese financial system is rotten, and so shorted the yuan. However, the Chinese system keeps rolling along and, under the current leadership, cross-subsidizations of all kinds are expected to continue. Linette Lopez of Business Insider points out that while the banks may be fragile, they are not conventional business enterprises and can be propped up as long the leadership deems it to be in the country’s interest. She says, “Sometimes, no matter how right you are, you're still wrong and you're still going to lose money.”
- Greece: The New York Post reports Bass supposedly made billions in 2012 by shorting Greece, but his fund gained only 16% that year.
- U.S. national debt, Greek debt, Japanese debt, Argentinian debt: No doubt much of the world is running up debt and will likely face a messy reckoning. But when? Bass thinks the reckoning should have come by now or will come soon. But most countries have found ways to stave off that reckoning, for the time being at least. In the meantime, he has struggled to get to mid-single-digit returns.
Lightning has not struck twice for Bass. The strategy that gave him so much in the mid-2000s has failed him since then. Has he misgauged or do the counterparties on the other side of his shorts possess some knowledge that he does not?
Holdings
This chart shows the sectoral allocation of the three equities held in Bass’ portfolio:
And this GuruFocus list shows the three equities:
Note the heavy holding in put options. These derivatives will rise in price if the price of Shire (SHPG, Financial) shares fall. Note as well that Shire is a biotech stock and one of the targets of Bass’ shorts on drug companies.
Performance
A couple of GuruFocus headlines tell the essential story of his performance:
- Kyle Bass – Stung By Losses, Hoping for a Comeback (Aug. 14, 2015)
- Troubled Kyle Bass Reduces Stake in NMI Holdings: Struggling hedge fund has experienced biggest losing streak in its history (Oct. 14, 2016)
In 2007, Bass had scored a return of 212%, according to a 2015 Institutional Investor article, which goes on to note that he had not had a big win since then. It also reports the Hayman Capital Master Fund had posted an average annual return over those eight years of just 1.56%.
This TipRanks chart shows how bad things have been for the whole firm over the past five years:
As we have seen with so many other gurus, adapting to a long bull market is tougher than it appears. Bass’ business model worked so well for one big crisis, then produced rocky returns for succeeding years.
Conclusion
John Maynard Keynes famously said, “The market can stay irrational longer than you can stay solvent.” He said that after personally misjudging the currency markets and enduring a major loss.
Over the past 10 years, Bass has done his homework and invested in situations ripe for shorting. However, the “markets” maintained their irrationality longer than he expected and, as a result, he lost many bets.
Value investors might learn from his experience. Investing in the belief the market must correct itself is a risky gambit. I am one of many who has predicted an end to the bull market for a couple of years now. Fortunately, I have not acted on the hunch so far.
Further, investors should be prepared to tweak their strategy over time, assuming the strategy has a solid base; if not, a new strategy should be considered. Mr. Market always has his own ideas and will continue to surprise us as long as we invest.
Disclosure: I do not own shares in any of the listings in this article, and do not expect to buy any in the next 72 hours.
