Wall Street superstar Barton Biggs, who died last week, was one of Morgan Stanley’s high-profile equity strategist, appearing regularly on CNBC and in Barron’s annual investment roundtable. Unlike many sell-side big shots, he actually invested in the stock market. Biggs eventually migrated to the “buy side” (Morgan Stanley Asset Management) where he was a pioneer in emerging market investing. After the tech bubble he left the brokerage business entirely and cofounded a hedge fund, Traxis Partners.
Biggs lived most of his life in Greenwich Connecticut, epicenter of the hedge fund industry. His 2006 book Hedge Hogging is an amusing and informative pastiche of fund manager profiles, as well as a savvy primer on investing in stocks, bonds, and art. We learn about fibonacci numbers, the relative merits of growth stocks vs. value stocks, the perils of group think in investment committees, and the “violence of secular market cycles.” Biggs captures the egomaniacal ethos of the hedge fund world through such characters as:
- Ian, who started his fund with only $8 million in the 2001 bear market. To get started he “sold his apartment and house in the Hamptons and moved the family into a grubby rental.” Ian is so intense that he sleeps with his portfolio and grinds his teeth in his sleep. Biggs liked that and gave him some money to run.
- Grinning Gilbert, who after a couple of good years during the 1990s tech bubble bought a mansion on Round Hill Road in Greenwich. Gilbert’s wife, “an aggressive, ambitious personality,” poured money into the house and “performed a full cannonball into the Greenwich social pool.” They moved into the mansion in 2000, at the apex of the tech bubble. But the fund withered over the next two years and a traumatized Gilbert retreated to his bedroom, subsisting on toast and soup for a week. Eventually they decamped from Round Hill Road for parts unknown.
- Vince, the “bearded profit of the apocalypse,” who opined to Biggs in 2005 that “Residential real estate is the next big disaster. People are borrowing short to invest long, refinancing mostly with floating-rate mortgages. When short rates go up, debt service payments will soar and house prices will decline. Then the consumer collapses from the double whammy of the wealth effect and shrinking disposable income.” Great call, Vince!
- Fayez Sarofim, the famous mutual fund manager based in Houston. Sarofim told Biggs that big pharma stocks such as Merck were cheap and attractive. Bad call— they were cheap for a reason and would get cheaper because of the new product drought.
Mostly inadvertently, Biggs shows why hedge funds are a problematic asset class unless you are lucky enough to hook up with a genius such as George Soros, Steve Cohen, or Leon Cooperman. Managers are under intense pressure to put up good performance sooner rather than later—before investors leave the fund. This can lead to short-term thinking, over-trading, and herd following. In bear markets some investors in a fund may panic and pull out, forcing the fund to sell stocks precisely when it should be buying. Hedge funds’ fee structure—2% of funds under management plus 20% of profits—creates perverse asymmetric incentives for managers. If a fund scores big the manager can get rich quick, which may prompt him to “swing for the fences” by taking excessive risk. On the other hand, if the fund declines sharply the manager may close it (or his employees may leave) because he can’t have a big pay-day (a 20% cut of profits) until after it gets back to the “high water mark,” the level where the fund was started. Yet another problem is tax inefficiency: most profits are short-term gains taxed as ordinary income rather than as long-term capital gains. Given these drawbacks – high fees, perverse incentives, tax inefficiency, and an unstable structure – hedge funds’ popularity is, frankly, rather surprising.
Mrs. Biggs’ Big Boring Score
Ironically, late in the book Barton Biggs gives us a fascinating example of a buy-and-hold strategy that looks a lot more boring and a lot more attractive than buying hedge funds. In the early 1970s Barton’s father, who was the Chief Investment Officer of the Bank of New York,
“was worried about his health and inflation and suspected my mother would outlive him by a considerable number of years . . . So he constructed for my mother a portfolio of growth stocks (and cyclical growth stocks) such as Phillip Morris, Caterpillar, Exxon, Coca-Cola, AIG, IBM, Citicorp. Hewlett-Packard, Berkshire Hatheway, GE, Merck, Pfizer, and so on – nothing very imaginative, but solid, long-term companies you would want to sleep with. When she died two years ago [circa 2003] at age 95, her cost on many of these positions was actually less than the current dividend. My mother’s portfolio compounded over 32 years at 17% a year….I figure the purchasing power of her income stream compounded at roughly 12% per annum…..My brother Jeremy and I watched her list intently, and from time to time, we did weed out and replace a few companies that we thought were beginning to falter.”
Mrs. Biggs’ real, after-inflation purchasing power increased 3,658% over 32 years. If she started with $10 million, she ended with $376 million. And the fund was exceedingly tax efficient.
Of course, this performance is a lot harder than it looks. Most people don’t have the CIO of the Bank of New York picking their stocks, or a shrewd Street strategist pruning the portfolio. And–even more important–it is not easy to stay fully invested through the 13.5% inflation of 1980, the scary 1980-82 back-to-back recessions, the 1987 stock market crash, the 1991 real estate crash, the 1998 Asian financial crisis, and the tech bust of 2000-2003. That said, it is actually not that difficult for most investors, with the help of a knowledge advisor, to successfully follow a similar strategy. The five keys to success are to steadfastly stick with sensible stocks, diversify across industry sectors, not go off on faddish tangents, sell your losers not your winners, and judiciously buy the leaders in dynamic new industries.
