From Whitney Tilson’s letter to investors for 2016 and Q1 2017 but first Q1 2017 excerpt on Fannie Mae
2016 Hedge Fund Letters
Q1 2017 Letters
Fannie Mae declined 33.1% in Q1 in the wake of an unfavorable court ruling in February. You may recall from the discussion in my annual letter that the stock nearly tripled in the wake of Trump’s election based on investors’ belief that the Trump administration would strike a deal to liberate Fannie Mae and Freddie Mac (the government-sponsored entities, or GSEs) from government control. Here’s an excerpt from an interview that Treasury Secretary Steve Mnuchin did with Maria Bartiromo shortly after the election:
Maria: “Would you move to have these privatized?”
Mnuchin: “Absolutely. We gotta get Fannie and Freddie out of government ownership. It makes no sense that these are owned by the government and have been controlled by the government for as long as they have. In many cases this displaces private lending in the mortgage markets and we need these entities that will be safe; so let me just be clear we’ll make sure that when they’re restructured they’re absolutely safe and they don’t get taken over again but we gotta get them out
of government control.”
Maria: “This is a big deal. These are huge institutions. You think that…if we saw that as not complicated, wouldn’t that have happened already…that it would get out of government?”4
Mnuchin: “Well, I think with this administration [Obama] it hasn’t been a priority. If it had been a priority it would have. And in our administration it’s right up there in the list of the top 10 things that we’re going to get done and we’ll get it done reasonably fast.”
In this scenario, I think the stocks of the GSEs could appreciate 4-10 times, but nevertheless, after the big run-up, I took some money off the table because this remains a highly risky situation.
The risks were underscored when a sharply divided appeals court recently ruled 2-1 to largely uphold a lower-court ruling that was unfavorable to the GSE shareholders. It was the wrong decision, driven, I believe, not by the legal merits of the plaintiffs’ case but rather by two judges not wanting to rule in a way that would enrich the investment funds who own most of the GSEs’ stocks, so I think there’s a good chance the decision is reversed on appeal.
But the primary way to win here remains a settlement between the shareholders and the Trump administration. This will take some time, but I think the risk-reward equation here remains favorable, especially at today’s reduced price.
This is my 19th year of professional investing. Given that this is an experienced-based business, one would think my returns would be getting better with time, but in fact the reverse has been true. It is thin gruel that I’m in good company – it seems like every day I read about another iconic money manager who’s hit the skids. I do not think it is a coincidence that this has happened at the same time as: a) the rise of indexing (chew on this staggering statistic: in the last three calendar years, investors sank $823 billion into Vanguard funds, 8.5 times as much as the net $97 billion added to every other mutual fund combined); and b) the rise of supercomputers/artificial intelligence.
Regarding the former, indexing creates a cycle in which money pours into the biggest mega-cap stocks, driving them (and the indices) higher. This causes active money managers (who tend to own smaller stocks) to underperform, causing their investors to redeem, thereby forcing the active managers to sell their stocks, driving them down, further widening the gap with the indices, leading even more people to throw in the towel and embrace indexing. Lather, rinse, repeat.
As for the rise of supercomputers/artificial intelligence, in the past 5-10 years, computers have surpassed humans at such enormously complex challenges as chess and driving a car. Is it unreasonable to think they’ve done the same for stock picking (at least in a complacent market)???
The question for active manager is how to play this? I am not willing to suspend my valuation principles and chase performance, which is what I believe a lot of human beings, index funds, and high-powered supercomputers are doing. Instead, I continue to look for stocks that are either undiscovered or situations in which I believe I have an edge, often by knowing one or more of the key people (recent examples include Mondelez, CSX and Pershing Square Holdings).
I don’t know when this bull market will end – but all of them eventually do…and when it does, we will be ready. As Buffett wrote in his latest annual letter:
Charlie and I have no magic plan to add earnings except to dream big and to be prepared mentally and financially to act fast when opportunities present themselves. Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.
Our fund today is very cash-rich, at 61% long (meaning 39% cash), and well hedged, with 19% short exposure.
2) A dozen years ago I co-founded a newsletter aimed at serious value investors, Value Investor Insight, that every month features in-depth interviews with two top value investors, in which they share their investment philosophy and history, as well as 3-5 of their current favorite investment ideas. It’s only $349/year ($325/year if you subscribe for two years; half price for students). To subscribe, just go to www.valueinvestorinsight.com/subscribe or call (205) 722-2197. Our latest issue is posted here.
Also, be sure to check out VII’s sister publication, SuperInvestor Insight, which follows the trades and holdings of 30 top value investors. Our latest issue is posted here, and you can subscribe at: www.valueinvestorinsight.com/subscribe.
3) A week from Saturday on May 6th I will be attending my 19th consecutive Berkshire Hathaway annual meeting in Omaha. If you’re going to be there, I’d like to invite you to two events on Friday evening and Saturday afternoon, both at the Omaha Hilton (I’m not sure which rooms; there will be signs):
- a) My friend Chuck Gillman and I are hosting our annual cocktail party from 8pm-midnight on Friday, May 5th. No agenda, no speeches, no dress code – just come, enjoy the drinks and snacks, and meet other value investors.
- b) Chuck and I are also sponsoring a casual get-together immediately following the annual meeting (~3:30) on Saturday, May 6th – just walk across the street or take the skybridge to the Hilton. It will end around 6pm.
To RSVP for either of these events, please email Ram at Ram@idwr-office.com and include:
- Which event(s) you plan to attend
- Your name as you wish it to appear on your nametag
- Your city as you wish it to appear on your nametag
I look forward to seeing you!
PS—You do not need to be a Berkshire shareholder to attend the meeting. Everyone has tons of extra credentials; if you want one from Chuck or me, email me and we’ll have one for you at our party on Friday night.
PPS—Hotel rooms in Omaha are hard to come by that weekend, but I always hear about a few rooms that become available because someone can’t make the meeting, so if you: a) have an extra room or b) need a room, email me and I’ll try to put people together.
4) Buffett released his annual letter last month and it was one of his best ever I think. Here are a few of my thoughts:
- My estimate of Berkshire’s intrinsic value has now reached $300,000/A share, based on $171,000/share in investments and a 10 multiple of pre-tax operating earnings (including insurance earnings) of $12,900. $171 + $129 = $300. (I haven’t yet had a chance to update my full BRK slide presentation, which is always posted here; I should have the updated one posted by May 5th.)
- It’s amazing that Berkshire’s float is now over $100 billion!
- I think these statistics that Buffett cites in his letter are incredible:
Low prices are a powerful way to keep these constituencies happy. In Iowa, BHE’s average retail rate is 7.1¢ per KWH. Alliant, the other major electric utility in the state, averages 9.9¢. Here are the comparable industry figures for adjacent states: Nebraska 9.0¢, Missouri 9.5¢, Illinois 9.2¢, Minnesota 10.0¢. The national average is 10.3¢. We have promised Iowans that our base rates will not increase until 2029 at the earliest. Our rock-bottom prices add up to real money for paycheck-strapped customers.
At BNSF, price comparisons between major railroads are far more difficult to make because of significant differences in both their mix of cargo and the average distance the load is carried. To supply a very crude measure, however, our revenue per ton-mile was 3¢ last year, while shipping costs for customers of the other four major U.S.-based railroads ranged from 4¢ to 5¢.
Both BHE and BNSF have been leaders in pursuing planet-friendly technology. In wind generation, no state comes close to rivaling Iowa, where last year the megawatt-hours we generated from wind equaled 55% of all megawatt-hours sold to our Iowa retail customers. New wind projects that are underway will take that figure to 89% by 2020.
Bargain-basement electric rates carry second-order benefits with them. Iowa has attracted large high-tech installations, both because of its low prices for electricity (which data centers use in huge quantities) and because most tech CEOs are enthusiastic about using renewable energy. When it comes to wind energy, Iowa is the Saudi Arabia of America.
- It’s really quite shocking how badly the five fund of funds Protégé Partners picked have done. All beat the S&P in 2008, but in the eight years since then, they’ve only won 5 of the 40 comparisons (five funds over eight years) (see pg. 22). We hedgies and active managers in general deserve the lashing Buffett gives us on pages 20-25.
5) A few hundred die-hard value/Berkshire/Munger junkies (he calls us “cult members”) joined me in February to hear Charlie Munger take questions for two hours at the Daily Journal annual meeting in LA. Posted here are Adam Blum’s excellent notes (8½ pages), followed by two handouts Munger distributed: a) a parody he published in 2011 called: Wantmore, Tweakmore, Totalscum, and the Tragedy of Boneheadia; and b) an essay he wrote in 1984 calling for increased taxes to discourage short-term trading in the market. The full video of the meeting is posted here.
In addition, Munger hung around for more than an hour after the meeting and took questions from the groupies (I say that affectionately, not pejoratively) who swarmed him. Alas, I didn’t know he’d do this so I missed it, but fortunately one of the groupies videoed it and posted links to 22 clips here. Here’s one funny one: when asked about his supposed friendship with billionaire supermarket magnate Ron Burkle, he replied, “I have not seen Ron Burkle in 35 years. He always tells people what a good friend he is of mine. I liked Ron Burkle’s father – he was our last customer for Trading Stamps. I liked Ron when he was eager, but Ron, when he’s made a lot of money, is a bit insufferable. He’s my good friend if you listen to him. The one he really knows is Bill Clinton because he furnished him with girls!” (Munger is referring to this story). He also talked about Mike Pearson and Valeant here.
6) I made a presentation at the Robin Hood Investors Conference last fall, which I’ve posted here. In it, I:
- Discuss why I’ve positioned my fund so cautiously;
- Reviewed the 12 ideas I pitched at prior Robin Hood conferences, including three still in my portfolio: Spirit Airlines and SodaStream (longs) and Exact Sciences; and
- Shared three current favorite ideas: Berkshire Hathaway (long), the Direxion Daily 20+ Year Treasury Bull 3x ETF (short; a bet on rising interest rates), and a new short idea, Wingstop (the latest version of my WING slides is posted here).
7) I gave a presentation a few weeks ago to Yale MBA students entitled Lessons From a Dozen Years of Short Selling, which is posted here.
8) Betting on Zero, the critically acclaimed (100% on Rotten Tomatoes and 7.6/10 on IMDb) documentary about Herbalife (which is one of my largest shorts), is now available for only $6.99 on iTunes, Amazon Video, Google Play and YouTube. I’ve seen it and it’s outstanding! It makes it so clear what a pyramid scheme Herbalife is and the harm it’s doing to so many of its distributors. You can watch the 2-minute trailer here.
8) Not long ago only a handful of people were willing to speak publicly about their short positions (so-called “activist shorting”) – Chanos, Asensio, Rocker, Ackman, Einhorn, and yours truly – but in recent years it’s become so widespread that I can’t keep track of it, so I use a very useful service, Activist Insight, which follows, sends immediate alerts about, and maintains archives of every activist short campaign. For a free trial, please contact Jim Bilodeau at firstname.lastname@example.org and use my name for a 10% discount (I get a credit toward my subscription cost for each of my friends who signs up).
PS—As you may have noticed, I don’t send out emails to this distribution list very often. If you would like to receive my more regular (roughly once a week) emails with articles and commentary related to investing, please email my assistant Leila at email@example.com. You can also email her if you’d like to unsubscribe.