Wednesday, July 11, 2012

Hedge Fund Market Wizards

“Big price changes occur when market participants are forced to reevaluate their prejudices, not necessarily because the world changes that much.”
- Hedge fund manager Colm O’Shea as quoted in Hedge Fund Market Wizards

William C. Nygren commenting on a new book: Hedge Fund Market Wizards
Being a big fan of Jack Schwager’s Wizard series of investment books, I eagerly read his newest book, Hedge Fund Market Wizards, and was not disappointed. In 1992, shortly after we had started the Oakmark Fund, I read Schwager’s first book, Market Wizards. Despite having been in the investment business for over a decade at that point, most of my reading had been about other value managers, so I was excited about learning from traders who used completely different investment philosophies than we used at Oakmark. It made me feel my age when many of the managers interviewed in Hedge Fund Market Wizards said how inspirational it was to read Market Wizards when they were in school! 
Like Market Wizards, Hedge Fund Market Wizards is a compilation of interviews with highly successful money managers. These managers range from those whose time horizon is measured in minutes to those who hold positions for years; from those who knew they wanted to invest when they were back in grade school to those who still aren’t sure investing is their calling; and from those with impeccable academic credentials to those without any degrees. But despite their many differences, their similarities were most striking: good intuitive math skills, intense competitive drive, strong work ethic, well-defined investment philosophy and disciplined risk management. And as in Market Wizards, most every chapter discussed early career struggles followed by the discovery of an investing approach that better fit the individual’s personality. I find the Wizard books so thought-provoking because, rather than being just a collection of stories about past investments, they provide insights into how each manager thinks. The quote at the top of this letter was one of my favorites from this book. As value managers, we often explain that we aren’t forecasting a giant change in the fundamentals of companies we invest in, but rather we expect the stock price to increase significantly when investors change how they think about our companies. When we bought Disney, investors were worried about its theme parks; we were focused on the growth of its most valuable asset, ESPN. When we bought eBay, investors were worried about its market share relative to Amazon; we thought PayPal was so valuable that we were getting its Marketplaces business for free. Today we are focused on the growth of Dell’s non-PC businesses, whereas investors are worried about declining sales of PCs, a division we don’t think we are even paying for. In each case, if we are right, the fundamentals will force investors to reevaluate their prejudices, and we will profit from the repricing of the stock.