Special Situations and Arbs was kind enough to ask me a few questions for this series, saving me from looking a little crazy and a lot pitiful by asking myself questions and answering them.
It is unusual for a Hedge Fund Manager to be so open about his ideas, line of thinking and actual stock selections. Your transparency gives SA readers a look inside a HF. Whys do you share so much?
Good question. Typically we have a fully sized position before I utter a peep, which allows me to be more open about positions. Also, in several occasions, we have filings with the SEC anyway, so our positions are not a complete mystery. I mostly share so as to not bore to death my social friends. SA allows me to connect on the topics that I care about with people interested in those topics as opposed to the poor souls whose only crime was to accept a dinner invitation. Do you want to hear about mutual conversions? I have a hard time reconciling myself to the fact that not everyone does.
Do you think other Hedge Fund Managers could add value to their business by becoming active on SA? If so how?
It is a fine platform, certainly my favorite, for idea dissemination. So it really depends upon whether one has ideas worth disseminating. Reactions from readers can help hone ideas, especially when they are from people with specialized knowledge that one does not already have. I doubt that it accomplishes much for asset raising as many SA readers appear to be committed do-it-yourselfers who may have little interest in investing in hedge funds.
What is one thing nobody on SA knows about Chris DeMuth?
That is a tough one as I've gotten to know some of the SA editors well, had SA people over to my work and my home, and shared notes on everything from my first investments at age nine to my current portfolio, and have detailed my various extracurricular activities. So whatever I say will probably have at least one reader chime in with an "I knew that!"
One thing few people on SA know about me? Krav maga. I am a dedicated student several times a week after the market closes. I have tried several times to think of an angle to incorporate something I've learned in krav maga into a blog or article with ramifications in the investing world, but so far nothing has come of it. It is not something that really comes up much, but it has been a big part of my life.
You have an arbitrage background. Are arbitrageurs made or born?
For arbitrage, one must have an intense focus and one must be, as Mr. Munger would say, a lifetime learning machine. These attributes are probably born. Then, people who spend all of their time and energy focusing on what they think matters and if they constantly learn and improve, they can make themselves better over time. So, it is a combination.
At Rangeley Capital, what do you consider your benchmark index to be? The market as a whole, event driven or other?
Other. I think about durations in 3-5 year increments, because that is the increment that our performance has a statistical significance given the number of positions that we have in that period. We should meaningfully outperform the riskless rate of return and do so by an amount substantially in excess of the amount of risk that we take.
Event driven investing has a binary aspect to it. There are some inevitable losses in that kind of investing. How do you handle the losses emotionally?
Some people are emotionally suited to handle investing and its inevitable losses. When asked why he made it, Bruce Kovner said in part that, "I stay rational and disciplined under pressure". Alas, not me. I am an anxious wreck who loathes every loss down to the last penny and expresses a level of emotional maturity that is frequently corrected by my 5-year old son. My saving grace is that I force myself to stay rational and disciplined, albeit with less equanimity than a Kovner. I fire myself from particular positions or for particular days and get away from investing. I do the right thing, but I don't enjoy being around myself when I lose. Were I to poll my colleagues (which I will not), I imagine that they might agree.
How many positions does Rangeley typically hold at a given time? Now?
A few dozen is typical. Now I am a bit lighter than typical.
How do you use options in the fund?
Options are useful tools for two of my purposes. First, they are useful when I want to be long or short, but I want to isolate a very specific price and date (such as a view around a potential corporate transaction or regulatory decision). Secondly, from time to time I own large positions that are consistent with my long-term view, but then get negative procedural checks indicating hiccups along the way. Options are useful for exploiting the opportunities from the hiccups without unwinding my core position.
Many people on SA know of you but not many know of your partner. Do you want to say a few words as to his value to Rangeley?
Rich is extremely focused on detailed fundamental valuation; he does deep dives into the finances of each of our investments. Additionally, he has spent time in management and in front of boards of directors, so he has the eye of a practical operator that gives him sound views on reasonable assumptions that we make regarding management and board behavior. Finally, he built and organizes our systems regarding the implementation of position sizing utilizing the Kelly growth criterion. That frees me up to focus on idea generation, event probability, and thinking through the optimal structure for corporate assets.
One of the things I appreciate about your involvement on SA is the volume of articles (on a wide variety of subjects related in someway to the stock market or investing) that you link as Stock Talks. There are so many. How can you read them all?
I hope that the quantity isn't a nuisance. I prefer to read books than white papers or articles, but pass on what I find most interesting among articles. I read every word and love reading. It would be hard to invest if one doesn't love reading because there is so much information to assimilate. I am an early riser and I simply ignore anything that I don't find either interesting or productive. That gets my time commitment to zero of many activities that are typically big time sinks for most people. I think about my portfolio and my time in much the same way and my job is to optimize. Part of that optimizing is a radical specialization of labor. My labor is reading and thinking.
Unofficially I would say there's nobody on SA that posts as much as you. How many hours per day on average do you spend on the site?
That is hard to say. As something that I'm thinking about? 18. As the only thing that I'm thinking about? 0.
What is the one thing you can't live without on SA?
Sharing ideas with Eli Hoffman.
What is the one thing you would change/add on SA?
I would like for bloggers to be able to customize the name of their Instablogs. I want mine to be called "Sifting the World" instead of "Chris DeMuth Jr's Instablog".
According to your website, your record of top long and short idea of the year has been sensational the past few years. When may SA readers expect to learn about your 2014 top long and short?
So far so good. We are pleased with how LORL is working out (although it is somewhat hard to see since they have paid out substantial special dividends through the years since that long was initiated) and we are happy that the TMF short, one of the few repeats, is redeeming itself after last year. Last year's short idea was anomalous relative to our experience shorting these leveraged ETFs.
Our top long and short will be announced before the first trading day of 2014 as always. We will offer some concluding thoughts on GPT and TMF, this year's long and short and we will offer something new. That something new will involve value, a catalyst, and a counterparty that is doing something other than maximizing value.
You have said you spend hours and hours searching for inefficiencies in the market. With so many intelligent people in the market why does an edge exist?
Usually, it doesn't. In the rare instances where it does, the counterparty has lost control of the situation somehow. We don't really pit out judgment against someone else's judgment. We provide liquidity to the capital markets where that liquidity is mispriced for a specific, peculiar reason.
What are the ingredients necessary for you to pull the trigger and place a trade?
A dollar of value has to be analyzable. It has to be certain within a band. It also has to be mispriced by an amount that is at least 10% and preferably 20% outside of that band. So I pay $0.90 for an actual dollar (a literal dollar, for example a SPAC with short term treasuries that I have the right to liquidate). But a $1 of expected value that is $1 give or take $0.20 we would grudgingly pay $0.70 or so and would be happy closer to $0.60.
What would you recommend to someone who is looking for relatively safe yield in this zero interest rate environment?
Earn more money and spend less money. If you are looking for relative safety in a low risk environment and can't find it, then don't force it. We are but humble analysts. We look and hopefully sometimes find, but we don't tell the market what to offer us and we certainly shouldn't pretend it is there when it is not just because we want it.
What are your current macro thoughts on stocks, real estate, bonds, cash, and commodities?
I spend between 99-100% of the energy that I dedicate to investing to firm-level research. In my opinion, investing is value investing and economics is microeconomics. But macro is as good a hobby as any. Stocks are expensivish, but that can go on for a while. I don't go out of my way for exposure, but when I see something on sale, I buy it without too much worry over macro noise.
I went long real estate for the first time in late 2011. So far so good. Expensivish, too. However, my number one favorite inflation hedge is to buy all of the things I'll ever want (that don't depreciate; this tactic does not work with lettuce or microchips). One acre, barn, lake or tree will equal one acre, barn, lake frontage, or tree in a decade or two and if that is what I want, I thought is sensible to simply buy them now. Whether they are worthless or priceless in nominal fiat currency will be pretty immaterial to me. I'll still own them and since my tastes don't change much, will still want them.
Bonds are not just expensivish, they are actually actionably expensive. We are short the long-bond in an investment that is our best and largest short for 2013. What could go wrong? The biggest problem is that Japan or another country or region could collapse first, causing capital to fly to the US long-bond and driving yields down, quite possibly driving them negative. In part, this investment effectively bought us interest rate protection for long investments such as GPT.
I love cash. Having liquidity, certainly more than one's average counterparty, makes it easier to make sensible decisions. My favorite place for cash is in mutual institutions, federally insured and awaiting potential equity offerings. If everyone kept enough cash, it would also be easier to be less reliant on your job. In turn, that would make it easier to walk away if your employer ever asks you to do anything morally compromising. You can just walk away and it is no big deal because the liquidity is there for your family for the foreseeable future.
While silver is cheap compared with gold and gold miners are cheap compared with gold, gold itself is still relevant as systemic risk insurance. Systems collapse. Complex systems tend to be able to hide the potential of that collapse better than they avoid collapse itself. So, one might want to moderate potential outcomes by spreading bets - some within our current system and some without. Gold is an important part of what one can store for eventualities outside of our current system.
Will we experience another 2008-2009 type meltdown this decade?
Yes, it is reasonable to expect that we will. We have not delivered but instead have reshuffled the leverage. Over the past five years, we've gone all in with our bet on short-term palliatives and appearance of stability. Either we have created a magical perpetual motion machine in which consequences can be put off for ever or this will have serious repercussions or. My preference is for the former but I am planning for the latter just in case.
If you could ask Warren Buffett one question what would it be?
Having read his letters, all of the books about him, and every set of notes that I could lay my hands on of his annual meetings, I believe that he is a worthy hero. I am particularly fascinated by the Buffett Partnership era. His recent investments at Berkshire Hathaway (BRK.A/BRK.B) are less applicable. We overlap more in his personal account, which he invests actively from time to time. We were both actively investing in Korea around the same time and were both pleased with the outcome. I don't think that I would ask him what, specifically, how he would invest Buffett Partnership money at a 9-figure scale because he would not answer (this would be my question if I could slip him truth serum first).
Instead, I want to better understand the jarring incongruity of a hero of capitalism in practice who is also such an opponent of capitalism in politics. I adore so much about his investing philosophy, leadership, ethics, philanthropy, frugality, and humor. His advocacy of a centrally planned economy with the better part of the GDP spent by government just doesn't seem to fit. Why? Is it to create more inefficiency to exploit? Protection money? Guilt? He would not need to go far to see the virtue of liberty -- his life is an argument for liberty and what free people can do with that liberty. Why not support liberty in politics with the enthusiasm that he has used liberty in all facets of his life?
SS&A, thank you for taking the time to come up with some great questions. I enjoyed thinking about the answers.