Martin Whitman

So many wonderful retrospectives were written about Marty Whitman during his lifetime that another seems superfluous—yet we just can’t help ourselves.

Whitman, the founder of Third Avenue Management, died last week at the age of 93. To financial journalists, he was a generous source and teacher about value investing, especially deep value, the kind that really meant investigating a company. He often picked up the phone to share an idea in his gravelly New York voice, or to critique a story. In fact, he loved teaching: He instructed students at Yale School of Management for decades and endowed the Whitman School of Management at Syracuse University.

For investors in his funds, he produced great returns for years and wrote pungent shareholder letters that rivals studied closely. (One from 2013 called the work of that year’s Nobel Prize winner Eugene Fama “utter nonsense” and “unscholarly.”)

Whitman focused on distressed debt years before it became popular. He believed in the primacy of the balance sheet versus the income statement, and read debenture documents as though they were comic books. He believed that companies were wealth-creating machines, partly through what he called “resource conversion,” including mergers and acquisitions and spinoffs. And he rarely sold his stocks. “The idea of selling was absolute anathema to him,” says Amit Wadhwaney, co-founder of Moerus Capital and a protégé.

All of this contributed to him beating the stock market by a wide margin over at least 20 years. He was “like a kid in a candy store when markets were imploding, says Curtis Jensen, a portfolio manager at Robotti & Co. and another protégé. “He was jogging into the trading room hourly to buy stocks that were getting marked down during the Long-Term Capital Management and Russian ruble crisis.”

Before he became a money manager, Whitman was an investment banker who did a hostile takeover of Equity Strategies, a closed-end fund. This became the foundation for Third Avenue Management, which opened its doors in 1986. Once Whitman bought the bankrupt bonds of Anglo Energy, he needled his lawyer, Tony Petrello, to join the new company, asking him, “Do you want to be a principal or an advisor?” Petrello eventually became CEO of Nabors Industries, one of the biggest drilling companies. Whitman served on the Nabors board until 2011.

“Better than most,” says Jensen, “he emphasized that only three to four variables counted in what would drive an investment: The rest is just noise.”

Whitman stepped back from his firm in 2012. Third Avenue has stumbled in recent years, ironically after a downturn in distressed debt sank its Third Avenue Focused Credit fund. Value investing has also struggled since the financial crisis. Assets fell. In a 2015 interview with Barron’s, Whitman said, “I don’t know if you could even call us a success after the 2008 redemptions. We never really came back. It’s been tough.”

Born and raised in the Bronx, Whitman favored sweatshirts and khakis for the office, and forthright, sometimes salty language. Once, chatting with Barron’s about a famous bankruptcy investor, he said, “The bankruptcy fraternity here is very small. [This person] goes out to dinner with them and schmoozes them. In this country, you litigate by day and fornicate by night. He’s very good at fornicating by night. I go home to my wife and children.”

Throughout his 70s, Whitman walked across Central Park daily to the office and back. He had a habit of running across intersections if the traffic light was about to change. In mid-conversation, he might break into a dead run to catch a train. In his later years, he sometimes announced to people, “Let’s make money the old-fashioned way.”

Now, investors must figure out how to do by themselves.

Buffett: 50% a year

“If I was running $1 million today, or $10 million for that matter, I’d be fully invested. Anyone who says that size does not hurt investment performance is selling. The highest rates of return I’ve ever achieved were in the 1950s. I killed the Dow. You ought to see the numbers. But I was investing peanuts then. It’s a huge structural advantage not to have a lot of money. I think I could make you 50% a year on $1 million. No, I know I could. I guarantee that.”

 -- Warren Buffett

Berkshire Hathaway track record

Warren Buffett has built a fantastic track record at Berkshire Hathaway, achieving a 20.9% return per year in 53 years, or a 2,404.748% total accumulated return. He did this buying great businesses at reasonable prices. He used insurance leverage, he took advantage of fiscal efficiency and he never paid a dividend.

His strategy evolved over time, as assets grew and he listened more to his partner, Charlie Munger (Trades, Portfolio). He focused on buying great businesses at reasonable prices. He did that investing in publicly traded equities but also in taking over businesses and bringing them under the Berkshire umbrella.

The 50% remark

But when Buffett made the “I think I could make you 50% a year” remark, he was not talking about managing a portfolio of many billions of dollars. He was talking about managing a few million dollars and having the “privilege” of investing in small and illiquid companies.

Buffett invested in this arena when he started his career in the 1950s. In 13 years, he did not achieve a record of 50% per a year (that could probably demand extreme portfolio concentration), but he managed to get close to a remarkable 30% a year. But more than just that, he achieved those returns with a portfolio management structure that maximized returns while controlling risks.

Clues to this type of portfolio management can be found in the master’s published Partnership Letters. These contain valuable insights into implementing investment strategies, identifying individual opportunities and actively managing portfolios.

The Partnerships' track record

Between 1957 and 1969, the Buffett Partnerships achieved an annual compound return of 24.5% net of fees (29.5% before fees). The annual return of the Dow over the same time with dividends was 7.4%. The Partnerships charged no management fee, took 25% of any gains beyond a cumulative 6% and agreed to absorb a percentage of any losses.

Generally, fund managers look to properly diversify their portfolios among sectors and geographies. And more often than not, they tend to stick to one process of investment selection. The problem is that over time, certain investment methods tend to be favored and others neglected.

Having a portfolio structure composed of three different investment strategies allowed Buffett to consistently approach the set of market opportunities with different lenses and choose the most convenient for long-term profit maximization and risk-exposure control.

Three investment strategies

Buffett’s system for managing the Partnerships was composed of three strategies, and each investment in the portfolios was cataloged with one strategy label. The strategies he pursued were: generals, workouts and controls.

They all had in common the fact that Buffett was looking for extreme cheapness and that he was looking mostly in the camp of small or micro caps. But each strategy accomplished one objective, and he masterfully managed the weight in each one according to where the opportunities appeared.

The "generals” category referred to undervalued stocks, the "workouts" category were the investments in special situation events and "controls," although rare, were the investments where the Partnership assumed, over time, an activist position, trying to get management to make moves that would maximize the value of the stock.

Over the next few articles, I will dissect each of these strategies and provide an overview of their adaptation to today’s investment scene.

Phil Fisher: Common Stocks and Uncommon Profits

Introduction

Scuttlebutt: then and now

The 15 points, part 1

The 15 points, part 2

Growth stocks vs. cigar-butt stocks

When to buy stocks

When to sell stocks

why all the selling?

Little changed fundamentally over the past two weeks with regard to interest rate expectations, earnings expectations and the potential length of a trade war with China. So why did the last week of November witness some of the strongest historical returns in quite some time and this past Tuesday saw some of the harshest selling in several years?

To understand what is going on you need to focus on psychology. There has been ongoing research trying to explain market sell-offs. Several researchers had an interesting idea to try to explain why intense market selling occurs: instead of looking for an economic explanation - a repricing of earnings due to a policy change or changing expectations of future interest rates - why not instead go and ask institutional investors why they sold during the market downturn.

The findings were fascinating but not surprising - what they discovered is the main reason large institutional portfolio managers sold during market corrections is that stock prices were falling. Investors were reacting to price movements instead of to changing fundamentals - the selling effectively snowballed because large institutional investors sold stocks because other large institutional investors were selling stocks.

The problem for today's market is that this lemming-like behavior of selling stocks because others investors are selling stocks is becoming a self-fulfilling prophecy due to algorithmic trading. If we look at a sample of three of the largest multi-strategy hedge-funds they might collectively manage only $100 billion dollars in assets but through leverage they can deploy half a trillion dollars. Additionally, most of these firms are focused on using leverage to generate returns on a very short-term time horizon.

Essentially, multiple firms, by analyzing past price movements independently through various means, have come to the same conclusion that the psychologists examining market corrections came to - that during large negative market movements selling accelerates.

The key lesson for investors is relatively straightforward - as much as possible try to ignore price movements when making buy and sell decisions and instead focus on changes in fundamentals. The silver lining in the increased volatility is that the higher volatility should result in a higher rate of return for long-term equity investors as they need to be compensated for the volatility which does not look like it can be diversified away.

-- Mitch on the Markets, 12/8/18

America oil exporter

America turned into a net oil exporter last week, breaking almost 75 years of continued dependence on foreign oil and marking a pivotal -- even if likely brief -- moment toward what U.S. President Donald Trump has branded as "energy independence."

The shift to net exports is the dramatic result of an unprecedented boom in American oil production, with thousands of wells pumping from the Permian region of Texas and New Mexico to the Bakken in North Dakota to the Marcellus in Pennsylvania.

While the country has been heading in that direction for years, this week’s dramatic shift came as data showed a sharp drop in imports and a jump in exports to a record high. Given the volatility in weekly data, the U.S. will likely remain a small net importer most of the time.

“We are becoming the dominant energy power in the world,” said Michael Lynch, president of Strategic Energy & Economic Research. “But, because the change is gradual over time, I don’t think it’s going to cause a huge revolution, but you do have to think that OPEC is going to have to take that into account when they think about cutting.”

The shale revolution has transformed oil wildcatters into billionaires and the U.S. into the world’s largest petroleum producer, surpassing Russia and Saudi Arabia. The power of OPEC has been diminished, undercutting one of the major geopolitical forces of the last half century.