We continue with our review of the most interesting chapters of Hedge Fund Market Wizards. Today, we feature Martin Taylor.
1. Managers often don’t have a choice but to keep riding a trend.
Although I was disgusted by Russia at the time, I had been willing to stay in it as long as it kept going up. I wasn’t going to argue with all the idiots who were buying Russia. If I had gotten out, and it kept going up, it could have been the end of my career. Remember, Russia was 40 percent of my benchmark.
You have to always be pragmatic enough to move with the market. You always need to be facing in the right direction.
Our macro views change quite regularly. You just have to be pragmatic. When you get it wrong, you need to get out immediately. I am wrong all the time. If I can be right 60 percent of the time, and when I am right I have some big winners, and when I am wrong, I staunch the losses quickly, I can make a lot of money.
2. This is how many trends end.
When markets are trending up strongly, and there is bad news, the bad news counts for nothing. But if there is a break that reminds people what it is like to lose money in equities, then suddenly the buying is not mindless anymore. People start looking at the fundamentals, and in this case I knew the fundamentals were very ugly indeed.
3. Follow the smart money.
You have to look where the smart money is. In an emerging market, the smart money is domestic, not international.
4. He is not a big fan of low-beta stocks.
Buying low-beta stocks is a common mistake investors make. Why would you ever want to own boring stocks? If the market goes down 40 percent for macro reasons, they’ll go down 20 percent. Wouldn’t you just rather own cash? And if the market goes up 50 percent, the boring stocks will go up only 10 percent. You have negatively asymmetric returns.
5. He prefers momentum names:
Do you always have high-beta stocks?
Absolutely—high-beta stocks balanced by cash or shorts. That has been true ever since I was a long-only manager. Boring companies never have the opportunity for earnings growth. And I like earnings growth, even though I don’t like paying up for it.
6. How to manage your investors’ expectations.
I always tell my new investors, “You will lose money investing with me at various points in the year, and it will always be unpleasant when it happens.” This health warning is crucial so that investors have proper expectations.
Being in a position of running people’s money, I can’t take extreme positions and maintain my mental equilibrium. Managing money is real life, not some bullshit strategist fantasy world. When the market goes up, I try is capture 70 to 80 percent of the move, and when the market goes down, I try to lose only 30 or 40 percent of it.
7. His net exposure varies between 20 percent net long to 110 percent net long.
I believe that if you’re trading very volatile instruments and you are completely out of the market when it reverses, then you will never get back in again. I will have some net long exposure even when I am bearish. For example, during the first quarter of 2009, even though I was still very bearish, I was 20 percent net long. As a result, when markets reversed to the upside in March, I didn’t feel bad about buying more, since I had made some of the money on the rebound. It was mentally easy for me to double my net long exposure to 40 percent. If, on the other hand, I had been net short when the turn came, I would have been waiting for a pullback to cover my short, and the pullback never came.
8. Having a feel for the market.
Maintaining a 20 percent net long exposure instead of getting out completely helped us avoid getting whipsawed by the quick succession of extreme peaks and troughs in late 2008. During the fourth quarter of 2008, there were three rallies of approximately 15 percent to 20 percent that all ended up being followed by new lows. If I had dumped our entire position, then when the market rallied 15 percent to 20 percent, after it had been down nearly 40 percent, I might very well have thought, “Oh, my God, this is the turn,” and jumped right back in again. Then when the market was back to a new low a few days later, I probably would have thought that I had been right to be out of the market in the first place and sold everything again. There would have been a danger of getting whipsawed on the subsequent short-lived sharp rallies as well. So while our net long exposure resulted in losses during the second half of 2008, ironically, we might have lost more if we had gone flat.
9. The challenging job of hedge fund managers.
Managing long-only money is really easy because if you are up more than the index, everyone loves you, since a huge majority of the managers, 85 percent or so, underperform the index. And even when you lose, as long as you are losing less in relative terms, people still love you. Whereas if you are a hedge fund manager, when the market is up, investors want you to perform like the market or better, and when the market is down, they want you to perform like cash.
10. He is looking for catalysts to unlock value.
The catalyst I monitor for a stock to realize value is earnings surprise. In the case of Apple, we are forecasting earnings 50 or 60 percent above the street for the next three or four years.
11. Technical analysis is an important tool.
I also use charts as an aid to adding to positions. If I am bullish on a stock but don’t have a full position, and then the stock breaks out on the chart, I will then go to a full position because the breakout confirms that the market is now seeing the same thing I am seeing.
12. Looking for bargains.
If a stock is extremely oversold—say, the RSI is at a three-year low—it will get me to take a closer look at it. Normally, if a stock is that brutalized, it means that whatever is killing it is probably already in the price. RSI doesn’t work as an overbought indicator because stocks can remain overbought for a very long time. But a stock being extremely oversold is usually an acute phenomenon that lasts for only a few weeks.
13. You need to have a clear reason to open a new position.
If you don’t understand why you are in a trade, you won’t understand when it is the right time to sell, which means you will only sell when the price action scares you. Most of the time when price action scares you, it is a buying opportunity, not a sell indicator.
14. Market corrections could alter investors’ psychology.
Normally, I let winners run and cut losers. In 2009, however, as a result of the posttraumatic effects of going through the September 2008 to February 2009 period—talking to clients who are going out of business and seeing 50 percent of your fund redeemed is all very wearing—I got into the habit of snatching quick 10 to 15 percent profits in individual positions. Most of these positions then went up another 35 to 40 percent. I consider my pattern of taking quick profits in 2009 a dreadful error that I think came about because I had lost a degree of confidence due to experiencing my first down year in 2008, even though the loss was consistent with the expected loss given the magnitude of the market decline.
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