August 17, 2011

Michael Steinhardt - Fund Manager

Beginning
Michael Steinhardt has his own zoo. One of his favorite pets is a blue crane which follows him around his mansion. But everything began when he was thirteen years old and got 200 shares from his father. The shares made him interested right away and every day after school, he took the subway down to a brokerage firm. At the brokerage firm, he could watch the ticker tape and try to understand how the customers placed their trades. Annual reports and other financial reports interested him as well. At age sixteen, he opened his own trading account. "I came to love the risk taking associated with trading and the rush that comes when the risk pays off," he said.
    Michael Steinhardt holds a degree in sociology from the University of Pennsylvania. The education was four year long, but Steinhardt finished it in three years. While studying sociology, he learned everything about human behavior. It proved to be an advantage at Wall Street – compared with if he had studied finance. Statistics was a part of the education as well – the art of how to make wagers with incomplete information – which is also a necessary skill at Wall Street.
    In 1960, Michael Steinhardt worked as a researcher for the Calvin Bullock mutual fund organization. Then he joined the army and he also worked as a writer for the Financial World. But the company fired him, so he thought his career on Wall Street was over. But at age 26, he founded the hedge fund Steinhardt, Fine, Berkowitz & Company. It was a co-operation with two friends who later left the hedge fund.

On his own
The hedge fund opened in New York in 1967. The first year, the fund increased with 99 percent. During the next 28 years, the fund produced an average annual return of 24 percent. But in 1994, the fund lost 31 percent and Michael Steinhardt was devastated. "When things weren't good, I couldn't be happy," he said. "I was immersed in my misery." The following year, the fund gained 20 percent.
    Michael Steinhardt is a trader. "Buy-and-hold is an incomplete strategy," he said. "It leaves so much on the table in terms of potential management." To be a good trader, one has to balance between the conviction to follow the ideas and the flexibility to recognize when one has made a mistake.
    At age 54, Michael Steinhardt decided to retire. After retirement, he invested his own money in different hedge funds. After the catastrophic year 2008 – when many hedge funds, who were supposed to be hedged, lost money – Michael Steinhardt removed his money from 60 percent of the hedge funds he had invested in. "When I was a manager, I thought it was a near disaster to have a down year," he said. "I don't think that managers today think in such terms."

Strategy
Michael Steinhardt began his career as a stock picker, but transformed into a macro manager. He chased macroeconomic trends by buying long and selling short stocks, bonds, and currencies. These are the secrets behind the success:
    Experience. One advantage Michael Steinhardt had was that he became interested in the financial markets when he was thirteen. "By the time I graduated from the university at nineteen, I was experienced," he said. "I had already made a lot of mistakes. The earlier you learn from it, the better. The best lessons always came from the biggest mess-ups."
    Experience is needed to be a good trader. Since Michael Steinhardt used so many strategies, it had made him wise beyond his ears. "You don't learn consciously as much as you learn subconsciously," he said. The subconscious goes through the incomplete facts, and leads to certain conclusions. Michael Steinhardt could trade on information based on his own subconscious conclusions. "They weren't always right, but they were worth listening to," he said.
    Variant Perception. The concept behind variant perception is basically that one has to have a contrarian approach. Michael Steinhardt always wanted to have a better understanding and a greater knowledge than anyone else in the financial markets. But it is very important to be a practical contrarian – not a theoretical contrarian. In order to win as a contrarian, you need the right timing and you have to put on a position in the appropriate size. He asked the following question to himself: "What do you know about this investment that the rest of the world doesn't?"
    To find out what the market doesn't know, Michael Steinhardt paid millions of dollars a year in commissions to Wall Street brokers. Thanks to the money, he got someone from one of the Wall Street houses to call him first every time they changed an analysis. Some Wall Street houses have so much influence that when they change an opinion they can move the market by themselves. For example, if he got the message "We're lowering our estimate on General Electric's earnings next quarter," he could short General Electric before everyone else and profit from the trade when the rest of the market got the news. 
    Long-term positions. Michael Steinhardt made most of his money from positions that had been held for more than a year. "I look first at the big picture of where the market is going and then try to find stocks to fit a portfolio that reflects my generalized view of things," he said. Most of the long positions were chosen based on their long-term fundamental prospects. But they are not always held for a very long time. Michael Steinhardt feels much more comfortable with many small gains – 5 percent here, 10 percent there – than to wait for distant events that may never happen. "The long term is a world of dreams," he said.
    Short-term positions. Michael Steinhardt claims one of the keys to his success was to combine a buy-and-hold investment strategy with a day-to-day or even hour-to-hour trader. He is prepared to speculate temporarily on the direction of the general market.
    Flexibility. Michael Steinhardt has a view that every day is a new opportunity to make money. Each day, he asked himself where the risk-reward ratio seems right on whatever markets are moving at the time. There is no absolute formula or fixed patterns. The markets are always changing and the successful trader has to adapt to these changes.
    Michael Steinhardt doesn't like to cut his losses quickly and he's not using stop-loss orders. He continuously re-examine the ideas behind his positions to make sure that he is correct and nothing has changed. It may be a random movement, but he wants to concentrate on it until he can establish that it is a random movement. "You never make big money in the market without getting in the way of danger," he said.
    As part of the contrarian approach, Michael Steinhardt has always shorted stocks that were favorites of and backed by institutional investors. Sometimes he's too early, and have usually started off with a loss – and sometimes he's wrong. But he holds the position as long as the fundamentals are unchanged. Sometimes if the loss is too big he might take 20-40 percent of the position and trade with it.
    What to buy or sell. Michael Steinhardt doesn't use charts. "Charts all seem the same to me," he said. "By watching stocks as closely as I do, I get some sense of price levels in my mind. I don't care how a stock has gone from $10 to $40."
    Lower-multiple dull stocks, laggards, with a recovery potential are the best stocks to buy long. He also prefers to buy stocks in companies that has a repurchase program. Such a program gives an additional boost to its upward movement.
    On the short side, Michael Steinhardt prefers to short the best known companies. They are often high-multiple, popular stocks with big institutional expectations built into the prices. The average exposure has been 40 percent net long. Sometimes the exposure has been 15-20 percent net short and over 100 percent net long.

Conclusions
  • One should begin as early as possible to gain the necessary experience.
  • One can use a contrarian approach to make money in the financial markets – to go against the general trend. But it's important to remember that an overvalued market can always be more overvalued.
  • It's important to be flexible – every day is a new opportunity to make money.

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