Wednesday, April 22, 2015

Stanley Druckenmiller is a pig / (on diversification)

Recently, fellow GuruFocus contributor Canadian Value posted the transcript from Stanley Druckenmiller’s speech to the Lost Tree Club from earlier in the year (link).

Let’s start with why you should care what he has to say: According to Sam Reeves, who introduced the speaker, Mr. Druckenmiller generated after tax returns for his shareholders of nearly 21% per annum over his 30 years managing outside funds (through 2010); at that rate, each $1,000 managed by Mr. Druckenmiller at Duquesne Capital was worth roughly $300,000 three decades later (fees aren’t mentioned in the transcript). And for the kicker, Mr. Druckenmiller never reported a down year over that period. [I find that hard to believe.]

In the speech to the Lost Tree Club, Mr. Druckenmiller spent a lot of time answering a question all of us are undoubtedly wondering: How the heck did he manage to do so well for so long?

I won’t waste your time by copying his entire speech, which is a must read; I want to focus on a single factor that he addressed in some detail:

"The third thing I’d say is I developed a very unique risk management system. The first thing I heard when I got in the business – not from my mentor – was bulls make money, bears make money, and pigs get slaughtered. I’m here to tell you I was a pig. And I strongly believe the only way to make long-term returns in our business that are superior is by being a pig. I think diversification and all the stuff they’re teaching at business school today is probably the most misguided concept ever.

"And if you look at all the great investors that are as different as Warren Buffett (Trades, Portfolio), Carl Icahn (Trades, Portfolio), Ken Langone, they tend to be very, very concentrated bets. They see something, they bet it, and they bet the ranch on it. And that’s kind of the way my philosophy evolved… The mistake I’d say 98% of money managers and individuals make is they feel like they’ve got to be playing in a bunch of stuff. And if you really see it, put all your eggs in one basket and then watch the basket carefully."

Later on in the speech, Mr. Druckenmiller tells a story from his early days as a fund manager:

"When I started at Duquesne, Ronald Reagan had become president, and we had a radical man named Paul Volcker running the Federal Reserve. And inflation was 12%. The whole world thought it was going to go through the roof, and Paul Volker had other ideas. And he had raised interest rates to 18 percent on the short end, and I could see that there was no way this man was going to let inflation go. So I had just started Duquesne and had a small amount of capital: I took 50% of the capital and put it in 30-year treasury bonds yielding 14% – and I owned nothing else… And sure enough, the bonds went up despite a bear market in equities.

"It shaped my philosophy: you don’t need 15 stocks or this currency or that. If you see it, you’ve got to go for it because that’s a better bet than 90% of the other stuff you would add onto it."

If you’ve read my writing in the past, you know I agree with that sentiment wholeheartedly; as usual, I think Warren Buffett (Trades, Portfolio) put it best: “Diversification is protection against ignorance. It makes little sense if you know what you are doing.”


Greenblatt’s strategy is nothing like Druckenmiller's, but there are a few philosophical similarities, namely that Greenblatt tended to put most of his capital into the 5 to 8 best ideas he had at any one time. He felt strongly that beyond this level, diversification didn’t really reduce any additional risk, but did water down results.

*** [me]

The key words are "if you know what you are doing."  Obviously Buffett and Munger know what they're doing, But I'd say the majority don't really know what they're doing.  So, IMHO, not diversifying could be a recipe for disaster.  Buffett actually recommends an index fund for most investors.

And how diversified is Buffett anyway?  Berkshire Hathaway owns 59 wholly owned (or practically owned) subsidiaries.  They also have 47 stocks in their portfolio, though 63% of that portolio is in four stocks (WFC, KO, AXP, IBM).

Looking at the 2014 letter, Berkshire's stocks were worth $117 billion.  They hold $42 billion in cash.  And according to celebritynetworth, Berkshire Hathaway is worth $144 billion.  So that means the businesses are worth less than zero (which can't be right).  This article calculates the business value at $91 billion (assuming a P/E of 10 on earnings). So that would make Berkshire worth approximately $250 billion.  They have 2 million shares outstanding (according to Morningstar), so that would make the stock worth $125,000 (current quote $215,000).

Well I guess he used to be less diversified in the early days.

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