Sunday, September 4, 2011

Andrew Redleaf Lecture at Yale Fall 2008

This is a lecture by Andrew Redleaf, co-founder of Deephaven and Whitebox Advisors. It was given in Fall 2008 to Prof. Robert Shiller's class at Yale (Shiller of the Case-Shiller index and Irrational Exuberance fame). Redleaf is not a natural public speaker ("graduated from Yale University in three years with a BA and MA in Mathematics and was recognized as the top mathematics student of his graduating year in 1978"), and there are no slides, so here are my notes. I have bolded what I found interesting.
Efficient market theory: two camps, yes/no.
A theory has to be predictive, and EMH is not: dual class stock, CEFs discount/premium to NAV, stubs, less volatile outperformance, certain outperformers, bubbles all refute EMH
Once the hardcore academic believers die, it will not even be an open question whether markets are efficient

But doing better than the markets is non-trivial (not impossible but hard)

For individuals, should stay within area of information advantage but they will not be diversified; also individuals have more limited access to products and information; less assets

For institutions, there is the constraints: liquidity requirements by outside investors (i.e. 30-day notice); institutional biases stemming  from individual biases; problems with decision making in the areas that have a mix of randomness and skill; understandable areas are fully random are easy; poker is similar to markets because of the randomness/skills mix; often someone who plays will admit to not being that much into it, why would they do tell you? Pet theory: setting up in advance to lose and easier to deal with internally . Other individual biases are causality just because one thing happened after another, recency, anchoring

What they try to do:
3 principles
(1) The investment world divides b/n coupon-clippers (cash flow-oriented investors) vs. re-sellers (owning to re-sell to someone at a higher price). There are successful people in both areas, and they make their money off the less successful people in the group. They are about the coupons: focus on cash flow. VCs are re-sellers: find an idea, sex it up, and get a good valuation from the public.
(2) Risk is primarily about what is the worst thing that can happen. Typical Wall Str risk management is about VAR: how wide is the range of probable outcomes. The VAR approach is fundamentally wrong but it done because statisticians are good at it, and it is hard to imagine the worst that can happen.
(3) Most at odds with the academics/general perception: you don't get paid for taking risk, you get paid for eliminating it. In the history of the planet, very few people have been paid for taking risk. A tightrope walker in the circus is an example: it is paid very well but you have to look at lifetime income, it is not that great if they fall. They are paid well because they have been working on training not to fall (=eliminating risk). Pharma drug development is uncertain risky business. Are they paid for the risk? No, they are paid for applying intelligence and eliminating certain compounds and combinations in advance. Insurance companies: if they are doing their job right, they should be avoiding risk. A casino does not have the risk that they will lose money because the law of large numbers takes care of it (the risk is in traffic/visits).

So we look at what is the coupon, what is the worst outcome, and how can we eliminate it? Sometimes it is diversification (independent positions; or sometimes offsetting positions, such as long a high yield bond and short the common in proportion is a simplistic example of clipping a coupon and reducing risk.

The next part is a discussion of events happening around the time of the lecture (November 2008) and Q&A.

Q: Are markets less efficient if prices are going up vs down?
A: No systematic view, but in recent years, more examples of overpricing but not clear if this is due to money creation.

Q: ??
A: An individual's default position should be cash; should invest only in compelling cases. Equities get cheap periodically by most standards. Recommends buying stocks now (Nov 2008). With the housing bubble taking off a few years ago, apartment REITs were interesting (below replacement cost) with compelling comparative yields (5-9%). Municipal bonds now yield more than equivalent treasurys, that's compelling. Has not happened since the fears of them losing their tax exempt status.

A: The long term argument for stocks in the US has strong survivor bias and has benefited from the US switching from agrarian to industrial. It is not clear at all whether the next 100 years will be like this.

A: Swensen of Yale Endowment has strong preference for equity; Redleaf likes fixed income securities a bit more because they are more analyzable inherently. Stocks have to be really cheap because they don't pay out earnings and in the future, they might do something stupid. Buying stocks at mid-single digit multiple for a good reason, you will get paid twice: multiple expansion and earnings growth. The market is telling you though that the earning are going down if the P/E is mid-single digit. RIMM is risky: very high multiple, it might not matter if they double earnings, and they'll never pay any dividends.

A: Involved investors are good (activists or direct owners). Executive comp is not the result of arms-length negotiations unlike hedge fund comp which is market-negotiated.

Final Q:??
A: Lengthy discussion of special situations where there is an event of default for delayed financials filing, and how they are active in it. They co-owned Sun Country Airlines with Petters Group (now a known massive ponzi scheme)

No comments: