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Bram de Haas
Articles (252)  | Author's Website |

In Defense of David Einhorn

The Institutional Investor and Bloomberg attacked Einhorn for mediocre results based on flawed reasoning

May 17, 2018 | About:

David Einhorn (Trades, Portfolio) is not having a great year, which was exemplified when investors recently pulled several billion dollars from Greenlight Capital. His losing streak has been going on for a while now, so the press is starting to pick on him a bit. This is especially noticeable as the Institutional Investor and Bloomberg just double-teamed him.

Full disclosure; Einhorn is a hero of mine. I have always, and continue to, viewed him as a great investor. I even own some shares of Greenlight Re (NASDAQ:GLRE), which is a reinsurance company investing in Greenlight Capital.

With that out of the way, I want to pen, as objectively as I can, a rebuttal to the Instutional Investor's piece. Paragraphs from the article willl be followed by my counterpoints. 

First off, the magazine wrote:

"The latest embarrassment for a former star who has not bested the stock market since 2009."

With the next paragraph, I'll dive a little bit deeper into performance, but early into this article we are immediately facing the common misconception that when your returns do not match the S&P 500, you haven't bested it. Einhorn has been running a long-short book biased toward the long end. The exposure hasn't been exactly similar to the S&P 500. You can argue it lags the S&P 500 return wise.

But it clearly bested the S&P 500 in risk control. That risk control hurt in retrospect, but what if you simulated the past nine years a hundred times. Does President Trump win the election (in which he received fewer votes) each time? Does oil go to $30 every time? Does the Federal Reserve invent quantitative easing each iteration? In hindsight, it's easy to see you didn't need to hedge, but if you never hedge you are going to caught at some point. It just hasn't happened for so long people start questioning the prudent guys like Howard Marks (Trades, Portfolio), Einhorn and even Warren Buffett (Trades, Portfolio).

The magazine continues:

"Perhaps more surprising, Einhorn has managed to underperform struggling peers like Bill Ackman (Trades, Portfolio), whose Pershing Square Capital Management has endured more than three years of losses and even bigger redemptions. Ackman is known for high-profile disaster bets on Valeant Pharmaceuticals International and Herbalife, yet his fund has managed to beat Greenlight since 2009, annualizing at 8.9 percent through April 2018, compared with Greenlight’s 4.7 percent."

This isn't surprising at all, unless you judge investment performance by the articles written on them in mainstream financial media. The simple fact is Ackman is something like 100%-plus long despite the one short position; he held Herbalife (NYSE:HLF) over the past nine years. I've defended Ackman at times too because he's been heralded too much in his great years and criticized to harshly in his bad years. But I'd say Einhorn's 4.7% is probably preferable to Ackman's 8.9% given the risk profile over these periods.

"Since then, however, Einhorn has been bombing at Sohn and elsewhere. His shorts on a string of companies — Green Mountain Coffee Roasters, Chipotle Mexican Grill, Athenahealth, Martin Marietta Materials, Pioneer Natural Resources Co., Caterpillar, Core Laboratories, Netflix, Amazon.com, and Tesla — are all either trading higher than when he announced he was short or were bought out at a premium, even though some had a temporary downward spike when he unveiled his bet. (He has acknowledged covering, at a loss, Green Mountain and Chipotle.)"

There is a misconception that you need your shorts to go to zero to do well in short selling. I don't think a legendary short seller like Jim Chanos (Trades, Portfolio) can even keep returns in positive territory. If you consistently run a short book, you are almost certainly going to lose money on it. Perhaps a lot of money, but that's all right because you receive collateral from your shorts. If you sell a share, you receive the money you sell it for. You can then hold that money and receive interest on it. This interest rate has been extremely low since 2009 and, interestingly, coincides with a period where hedge fund after hedge fund and every dedicated short seller except Chanos (OK, this is a stretch) is closing shop. Alternatively, you can reinvest some of the collateral, but if you run a large short book, it's unwise to reinvest it all. Even though you will lose money on a short book, it can greatly improve your short profile. If you lose, it can substantially add to your outperformance over time.

"Known exclusively as a value investor, Einhorn is a long-short equity manager who makes most of his money on the long side. But it’s his bets against stocks that made him famous and draw many like-minded investors to him. 'There is a mythology around him,' says one. Some even believe that his success and theirs are entwined.

'He’s a terrific guy, and I’m sure he’ll come back,' says Mark Spiegel, managing member of hedge fund Stanphyl Capital Management, who got to know Einhorn when the famous manager asked Spiegel to make a Tesla short presentation at the Robin Hood conference in 2016 (instead of making one of his own). Spiegel’s Tesla short, so far, has cost him as it has Einhorn, but he believes the stock will eventually be at zero."

It's not that crazy that many value investors feel their success is entertwined with that of Einhorn. He runs a diversified long-short portfolio: short momentum stocks and high-flyers while investing in many classic value situations with a lot of free cash flow or assets. In 2015, a plethora of value managers had a bad year, including Einhorn. Value investing itself hasn't done very well for the past decade, and many a value manager is struggling to keep pace with the torrent that is the S&P 500.

"Last year Greenlight detoured from its traditional mandate to make a high-profile activist play in GM, proposing it split into two share classes — one that would receive dividends and one that would participate in growth and earnings. “This was pure financial engineering with no long-term operational or strategic value creation . . . done by an inexperienced activist investor,” wrote Ken Squire, the founder of 13D Monitor, which tracks activists’ holdings, in his year-end review. Squire labeled Greenlight’s GM proposal, which was defeated by 92 percent of shareholders, the worst activist campaign of 2017."

This proposal wasn't all that bad. It could have worked great, but it may have been a bit too much of a frontier for General Motors (NYSE:GM). It surely sparked a lot of discussion and highlighted General Motor's free cash flow. The automaker has also been buying back stock and shutting down underperforming overseas assets. Sure, Einhorn didn't get his way with the dual share plan; the stock price did just OK. Otherwise, it seems to be a fine activist play. Einhorn has never been a super outspoken activist, but he's been talking to management teams behind the scenes for a long time.

"But Einhorn’s shorts on Amazon and Netflix — part of what he calls his 'bubble basket' of some 20 to 40 stocks — are head-scratchers to those who think those companies are growth machines that are here to stay. 'Obviously when we do have a market turn, you’d think those highfliers will get dinged,' says Ben Carlson, director of institutional asset management at Ritholtz Wealth Management. 'But they’ve had such a huge gain, they’d have to have enormous losses for him to break even.' Those stocks are up 38 percent and 64 percent, respectively, this year alone. Since the fall of 2015, when Einhorn first mentioned them as shorts, they have tripled."

Again, shorts don't have to make you money. Having said that, these were definitely big losers. But Einhorn specificially said these were part of a short basket. Small positions in high-flying momentum stocks. These can have huge drawdowns when they do fall. They just didn't.

"It has already been a wait. As long ago as 2012, Ritholtz Wealth Management’s Carlson says he noticed an Einhorn tell when the manager penned an article for the Huffington Post called 'The Fed’s Jelly Donut Policy.' In it, Einhorn took issue with the Fed’s easy-money policy, comparing it to sugar addiction. He had already been stocking up on gold — which other value investors like Warren Buffett eschew because it’s an asset that doesn’t produce anything. (Einhorn has a locker in Queens to hold physical gold and has offered investors a gold-denominated share class.)

Carlson says this 'style drift' was common among hedge fund managers he surveyed while doing due diligence in his previous job as an institutional financial adviser to nonprofits and foundations. The managers were bottom-up stock pickers precrisis, but their 2008 losses amid the financial meltdown turned their worldview upside down, leading them to a macro analysis that for years has been wrongheaded.

'A lot of it came from a misunderstanding of the Fed and what it was doing. They underestimated its power and expected hyperinflation, which didn’t happen,' he says."

I've highlighted the above paragraphs because it contains another common misconception. There is very little debate about the fact the Fed took historical unprecedented steps by lowering interest rates to zero and embarking on quantitative easing. With the implementation of each program, an extension few would have predicted beforehand occurred. In hindsight, the best thing would have been to run a big, fat 100%-plus long portfolio and make money hand over fist.

Let's say the monetary experiment worked out differently. How would a 100%-plus long portfolio worked out then? Perhaps disastrously? Instead, Einhorn navigated this historical time, as did many smart money peers, with a percentage of assets in gold, by keeping a long-short book and by picking stocks as best as he could.The returns in an absolute sense did not keep up with the market, but in terms of risk control, he's been leaps and bounds ahead of the S&P 500 index fund. To criticize the results with hindsight seems too easy to me. Show me the articles calling for 130% long in 2010.

I don't think Einhorn's results have been that bad. From his stock picks, which I follow eagerly, I'd say he hasn't lost it. There are a lot of great ideas in his portfolio and I'd bet against 99.9% of people trying to outdo him going forward.

Disclosure: Long GLRE.

About the author:

Bram de Haas
Bram de Haas is the managing editor of The Black Swan Portfolio

Visit Bram de Haas's Website


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Comments

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

Not sure I understand your thesis. Einhorn's performance can only be based upon objective results. His results have been relatively poor over a lengthy period of time. Many smart people underperform. When you pay an investment manager, you have expectations; when those expectations are not met, you look elsewhere. Running a long/short portfolio does not require the manger to be short at all times or even at all (unless a set percentage short position is required by the fund's charter, which would tend to turn off most reasonably minded investors). I find the opinions of Institutional Investor and Bloomberg objectively stated. Your opinions seems to offer excuses for underperformance. Your article reminds me of another "smart" money manager - John Hussman (Trades, Portfolio). Unfortunately, he too is too smart for his investors' own good.

Bram de Haas
Bram de Haas premium member - 1 week ago

When you pay an investment manager, you have expectations; when those expectations are not met, you look elsewhere

If you mean expectations of certain returns that's a bad idea. It's better to evaluate thinking/philosophy/expenses and if you like the mix stick with it especially through bad times

Running a long/short portfolio does not require the manger to be short at all times or even at all (unless a set percentage short posision is required by the fund's charter, which would tend to turn off most reasonably minded investors).

I think this is the case. I don't know the exact deal but Greenlight typically has a net exposure in the 30's or so. He's had two down years since inception. We lack the data to objectively evaluate his performance. Subjectively I don't think it has been all that bad. What you think is an objective evaluation in those articles are a bunch of cherrypicked numbers.

stephenbaker
Stephenbaker - 1 week ago    Report SPAM

I think we can agree to disagree. Of course I have expectations of certain RELATIVE returns when I pay an investment manager. If a professional cannot outperform a default index that costs very little, what precisely is the point? At the end of the day, you have an account with the cumulative results of your manager's performance reflected in the account value. For the typical individual ( as opposed to institutions, pensions and insurance companies that admittedly have other requirements) nothing else should matter. Buffett has it exactly right: You can bet on America with a simple, inexpensive investment. If you know of an investment that is superior to America, please do share. Otherwise, America is a logical default position for the typical individual investor with a long term horizon. If an investment professional charges you to underperform America, why bother?

Bram de Haas
Bram de Haas premium member - 3 days ago

I don't agree with but understand the idea that a manager should outperform an index. I don't think Greenlight should be measured against the S&P 500. Neither do I think Pershing Square should be measured against the risk-free rate (or something similar which I think it chose for its benchmark).

However more importantly Einhorn completely crushed the S&P 500 since inception. It is a choice of the author of said articles to deliberately take a smaller sample size (one that is arguably a very unusual sample) when a larger one is available to make a judgement call about his skill.

The end result is an extremely poor portrayal of Einhorn's actual ability. Certainly it's not an objective method to rely solely on recent results though you could make the case to overweight them slightly.

Betting on America is fine (which is very different from betting on the S&P 500) but I do think you are better off betting on the world. I want to bet on America and the next America.

stephenbaker
Stephenbaker - 3 days ago    Report SPAM
Brian, I don't think 8 or 9 years of underperformance should be ignored. A similar argument to yours can be made for money managers such as Bruce Berkowitz (Trades, Portfolio) and John Hussman (Trades, Portfolio); they are smart and have historical track records that beat the S&P 500 index. I think some money managers lose sight of the fact that the playing field has significantly leveled in the past 20 years between "professionals" and typical investors. Money managers no longer have the same amount of proprietary information they once had. The average investor has the opportunity to learn as much about his/her investments as desired, and the fact that indices outperform most investment professionals is not lost on the average investor. I look at Einhorn's recent performance as a reversion to the mean, rather than as an outlier to otherwise significant outperformance. Again, this is no criticism of Einhorn per se, but a belief that anyone who seeks to outperform with the use of short positions is setting themselves up for failure in the long run.

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