David Tepper is an the founder of the hedge fund Appaloosa. Bloomberg writes that Appaloosa “invests in the equity, fixed income, and hedging markets. For the fixed income investments, the firm invests in high-yield bonds, bank loans to highly-leveraged companies, sovereign debt, debt of distressed companies, and other debt securities. It employs a fundamental analysis to make its investments.” The Reformed Broker (Josh Brown) adds: “If you had put a million dollars with David Tepper when he started Appaloosa 20 years ago, it would now be worth USD 149 million net of fees.”
1. “We have this saying: The worst things get, the better they get. When things are bad, they go up.”
This is David Tepper’s version of Warren Buffett’s view that the time to be greedy is when others are fearful. The principal cause of significantly mispriced assets is when Mr. Market is fearful. If you can be brave and aggressive at such times perhaps you have one of the attributes of a successful distressed asset investor. The problem is that vastly more people think they can be brave and aggressive at times like this than actually can do so. While Warren Buffett and David Tepper view the same phenomenon (fear) as an investing opportunity, the way they capitalize on the opportunity is very different. Both Tepper and Buffett know that Mr. Market is bi-polar, but they operate in different ways (e.g., operate in different time scales, with different circles of competence; different systems; different temperaments).
Most everyone should buy a diversified portfolio of low-fee/no load indexed investments. The fact that a very small number of people like David Tepper exist does not change that fact. Some fund managers find it easier to give advice by pretending that people like David Tepper don’t exist since it makes their narrative simpler and their job easier. Academics are often hired to deliver a simple message which basically says: “It is impossible to beat the market. It can’t be done.” This approach is attractive since it means that no client must be told that they are lacking the skills or temperament to succeed as an active investor. A message delivered to a client that essentially says “it is impossible to beat the market” goes down a lot smoother than: “it is impossible for you and most everyone to beat the market.” Many clients benefit from hearing this message since otherwise they would try to beat the market and inevitably underperform. The motivation of the fund saying “you can’t beat the market, period” is arguably not improper. It benefits most all people to say this.
The reality is that investors like David Tepper do exist. But the bad news is: 1) the small number of people like him most likely won’t take you on as a limited partner and 2) you are very unlikely to be able to do what investors like David Tepper, Seth Klarman or Howard Marks can do on your own.
2. “Markets adapt. People adapt.”
People have a tendency to extrapolate from the present in trying to predict the future. Many pundits make their living extrapolating X or Y to the sky or to the ground depending on the most recent trend. David Tepper makes the point with an example: “In 1898, the first international urban-planning conference convened in New York. It was abandoned after three days because none of the delegates could see any solution to the growing crisis caused by urban horses and their output. In the Times of London, one reporter estimated that in 50 years, every street in London would be buried under nine feet of manure.” The nature of capitalism is that often the remedy for high prices is high prices and low prices is low prices. Incentives are created and people respond in a capitalist economy by adapting based on price signals. David Tepper likes to make bets against people who don’t believe markets will adapt. He stuffs perma-bears and perma-bulls in his game bag.
3. “We won’t stop if we’re down a little bit. We don’t freeze. We keep investing with a disciplined, logical approach.”
Michael Mauboussin points out: “You must recognize that even an excellent process will yield bad results some of the time. If you are going to be the in the business that David Tepper is in you need to stay focused on your process, rather than any specific short term result. If you make an investment and the odds are substantially in your favor and you generate a loss, that is OK as long as your process was sound.
A sound process exists when the process is net present value positive (i.e, genuine investing). If the process is net present value negative, that is gambling/speculation/a fool’s errand. Howard Marks points out the key elements in his process as follows: “a) have an approach b) hold it strongly c) accept that, no matter what, there will be times where your approach doesn’t work, and d) work within your own skill set and personality, not someone else’s.” David Tepper, Howard Marks, John Bogle, George Soros are not you and vice versa. Your investing approach should be consistent with who you are. Everyone is different. In addition to being disciplined and logical, David Tepper believes: “We’re pretty unemotional when we invest” which is a very good thing since most mistakes in investing are based on emotional or psychological errors.
4. “We invest in a lot of bonds and preferred (stock), which we can convert to equity. It not as risky as people make it out to be.”
When you make an investment in distressed debt your ownership interest can (under certain circumstances) convert into equity ownership, which gives you certain control rights that can be helpful in generating the return you desire. People who understand areas like bankruptcy and finance can do things like determine what is likely to be the “fulcrum security” which will convert into sufficient equity to exert some measure of control when the business restructures via a plan of reorganization. This sort of activity combines investing with the profession of distressed investing/bankruptcy. Distressed investing is not an activity where amateurs and people learning on-the-job experience a positive result. That David Tepper can do it does not mean that you can do it.
5. “This company looks cheap, that company looks cheap, but the overall economy could completely screw it up. The key is to wait. Sometimes the hardest thing to do is to do nothing.”
People have a tendency to believe there is a prize for hyperactivity. Not only is there not a prize but hyperactivity instead imposes significant penalties. Warren Buffett likes to say there are no “called strikes” in investing. For this reason, sometimes sitting on your hands can be the very best thing you can do as an investor. Patience is key. But so is aggression when the time is right, as was the case, for example, in 2009. The combination of being patient and yet sometimes aggressive seems odd for many people, but it is the right approach. When bargains do appear it is not only a rare event, but a fleeting event. If you snooze when a bargain appears, you lose. Fortune favors the person who is patient, brave, aggressive and swift to act when the time is right. Times like March of 2009 appear rarely in a lifetime for an investor.
6. “For better or worse we’re a herd leader. We’re at the front of the pack. We are one of the first movers. First movers are interesting; you get to the good grass first, or sometimes the lion eats you.”
To outperform the market you must be contrarian, and you must be right about that contrarian view often enough so that the financial math works. But there is big risk and uncertainty in this approach. The good news is that because most people would rather fail conventionally than succeed unconventionally assets can sometime be mispriced. Howard Marks, again, is on the mark: “Non-consensus ideas have to be lonely. By definition, non-consensus ideas that are popular, widely held or intuitively obvious are an oxymoron. Thus such ideas are uncomfortable; non-conformists don’t enjoy the warmth that comes with being at the center of the herd. Further, unconventional ideas often appear imprudent. The popular definition of “prudent” – especially in the investment world – is often twisted into ‘what everyone does.’”
7. “There is a time to make money and a time to not lose money.”
There is a time to reap and a time to sow. There is also a time to be defensive and not lose money. Sometimes almost all potential investments are properly put in the “too hard” pile. At times like this, the best thing you can do is preserve what you already have. Investing is a probabilistic activity. If you don’t have an investing thesis that is the output of a sound investing process which is net present value positive, then don’t invest. It’s that simple. Having a “too hard” pile is such a huge advantage in life.
8. “We don’t want to be bigger than we can invest.”
“The question is what size gets you – except more fees for the manager. But it doesn’t necessarily make the investor more money.”
Part of what David Tepper is saying is that he would rather be an investor than an asset gatherer. A smaller fund in which he has a greater personal stake can be a far better outcome for him than trying to make a lot of fee-based income from investing the capital of other investors. He also believes there is no optimal size for every fund. Size matters. David Tepper explains: “Say you want to buy 5 percent of a USD 2 billion company, and have it be meaningful. That means it’s a 1 percent position in a USD 10 billion fund. So if you’re an equity fund, if you keep getting bigger and get to USD 20 billion, that means your position is now only a half percent position. The 1 percent position doesn’t do much for the fund and so the half percent position does half as much. So there’s an aspect to the business, in equity funds especially, that gets funky on size.” The other problem that people have learned the hard way in many cases is that as you grow assets under management, it becomes harder to find opportunities. For example, Charlie Munger points out: “The future will be harder for Berkshire Hathaway – we’re so big – it limits our investment options. But, something has always turned up.”
9. “Replaying losses in your head is the only way you learn from your mistakes.”
As I said in my post about Keith Rabois, you can’t simulate investing. The way to learn to invest, is to actually invest real money (preferably your own money) so you have actual skin in the game. And when you invest and fail, you should be “rubbing your nose in your mistakes” as Charlie Munger suggests. When you inevitably make mistakes and get feedback, if you don’t learn from that you are not going to build up an edge versus other investors.
10. “Some of our best positions were ones we initially lost money on.”
An investor can be too early or too late and still win. David Tepper is not afraid to lose money if he believes he has followed a sound process and performed a sound analysis. Most people can’t put their fears aside and so they often sell at the worst possible time. This is sometimes called “performance chasing” or “the behavior gap.” A very small number of people have ice in their veins when it comes to investing. David Tepper knows fearlessness is a key part of his investing edge and that without an edge investment out-performance is unlikely. That you will have the same fearlessness as David Tepper, particularly if you will lose your home or will live in poverty as a retiree if you make a mistake, is highly unlikely. Betting fearlessly with what gamblers call ‘house money’ is far easier than making bets where one possible outcome is that you lose your house.
11. “After you work on Wall Street it’s a choice, would you rather work at McDonalds or on the sell-side? I would choose McDonalds over the sell-side.”
The sell-side provides services to clients for a fee. There’s an old joke that goes like this: “What’s the difference between the buy-side and the sell-side? The buy-sider curses at you and hangs up the phone. The sell-sider hangs up the phone and then curses at you.” The sell-side is selling and will tell you what you want to hear. The sell-side’s job is to directly or indirectly generate fees. Sell-siders do not have what Nassim Taleb calls “skin-in-the-game.”
Ben Carlson has described the life of a sell-sider: “When I worked on the sell-side the head of research pulled up the total number of buy and sell recommendations from every analyst during one meeting, there were only 3 sell calls — in the entire firm. He was basically begging these analysts to make a sell recommendation or two. Yet they weren’t really budging because… Relationships Matter. What I came to realize is that all of the number crunching didn’t matter nearly as much as the meetings and conference calls with company management. These relationships all carried much more weight than the financial models that the junior analysts toiled away at back at the office. The analysts didn’t seem to want to make a critical call against a company in fear of upsetting the management relationship where they got their questions answered.”
12. “What’s bad is good and what’s good is bad, right? You’ve got a long life. Don’t get upset by setbacks. Setbacks are another way to say opportunity.”
Opportunity comes in strange, lumpy, and often nonlinear ways. Success rarely takes the form of a steady process similar to climbing a ladder, nor does failure operate in the other direction. Modern careers are more like a jungle gym on a playground than a ladder. There are many examples that illustrate this point. Michael Bloomberg was fired before he started his information services business. David Tepper himself was passed over for a partnership at Goldman, which ended up making him both richer and happier with his life.
If life deals you lemons, make lemonade. Resiliency is a far greater determinant of success in life than most people imagine.
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