Whitney Tilson’s email to investors discussing God, money, YOLO: how Cathie Wood found her flock; the perils of investor overconfidence.
Q2 2021 hedge fund letters, conferences and more
How Cathie Wood Found Her Flock
1) I read this recent New York Times article with great interest: God, Money, YOLO: How Cathie Wood Found Her Flock. Excerpt:
As Tesla (TSLA) struggled with production problems, dwindling cash, and an erratic Mr. [Elon] Musk in 2018, Ms. Wood gave a full-throated defense of the company, her largest single holding. That began an unlikely mind meld between Ms. Wood and the new generation of tech-focused, risk-hungry people who started trading in droves in 2020.
On paper, she seems an odd standard-bearer for these younger, diverse, and deeply irreverent ranks of retail investors. Ms. Wood is a 65-year-old creature of Wall Street's asset management industry and the well-heeled Connecticut suburbs, as well as a deeply religious donor to conservative political campaigns.
I wouldn't say I'm obsessed with Cathie Wood (though some of my readers might disagree, as I wrote about her in February, March, April, April again, May, May again, and June!), but I'm definitely fascinated...
I admire many things about her: her enormous success, especially as a woman in a male-dominated industry (I wrote two articles on this topic for the New York Times website in 2014: Evaluating the Dearth of Female Hedge Fund Managers and A Deeper Conversation on Women in Hedge Funds)... the fact that she got to the top in large part by simply outworking everyone else... and her conviction in her ideas, most notably when it comes to one of the most controversial stocks of all time, Tesla.
And while her balls-to-the-wall investment style, taking large positions in high-growth, emerging technology companies, isn't for me, I don't dismiss this approach either. In fact, in many ways it mirrors what my colleague Enrique Abeyta does so well. I think it's healthy that the three lead investors here at Empire Financial Research – Enrique, Berna, and I – have such different approaches and areas of expertise.
That said, I haven't changed my view that investors should avoid ARK Invest's funds, for four primary reasons...
First, Wood reminds me a lot of former Morgan Stanley (MS) tech analyst Mary Meeker, who correctly saw the importance of the Internet in the late 1990s and became known as the "Queen of the Internet" – right before the bubble burst...
Second, ARK's assets under management ("AUM") soared more than 10-fold last year and now exceed $50 billion. I don't think it's a coincidence that ARK's performance has stunk ever since... The flagship ARK Innovation Fund (ARKK) – which accounts for nearly half of the firm's assets – is down 4% this year versus 20.4% and 18.8% gains for the S&P 500 Index and Nasdaq Composite Index, respectively.
AUM growth dragging down returns is an issue for nearly all successful investors, as high returns attract capital, but I think it will prove to be an especially difficult one for ARK to overcome, as the highest returns among emerging growth companies are generally earned by those who invest in them while they're small – something ARK can no longer do, at least in any size.
Third, I think the fact that ARK discloses all of its trades every day is very risky. All is well and good when assets are growing or stable... but if investors start to pull money, ARK has no choice but to sell. This is bad enough if done quietly – I've had to do it myself – but if you're a large shareholder and others see you selling, they're going to scramble to sell (or short) ahead of you, putting even more downward pressure on the stocks you're selling, which leads to more poor performance, more redemptions, etc., which can quickly turn into a dangerous downward spiral...
Lastly, this comment in the NYT article by one of the people Wood worked for early in her career raised a big red flag for me: "I've never met anybody with as much conviction. It's almost mystical, to be very honest with you." It further reinforces a gut feeling I have that she may suffer from dangerous overconfidence.
To be clear, being a successful long-term investor requires a high level of confidence, rooted in good data and analysis.
But it must also be accompanied by a great deal of humility – in particular, to: a) understand that most of the time, the market is right and you're wrong... and b) you must be willing to accept new/disconfirming information, change your mind, admit mistakes, and exit formerly beloved positions.
My extensive experience is that almost everyone in this business has an abundance of confidence... What they're missing is the humility! This is especially true when someone has a run of extreme success.
I've seen again and again (to some extent, it happened to me as well) how making a ton of money and being fawned over by the media can turn the brains of even the most rational, appropriately self-confident investors into total mush – and when this happens, the end result is almost always a train wreck.
The Perils of Investor Overconfidence
2) Getting the balance right between confidence and overconfidence is so important that I've been studying it for more than two decades. In fact, it was the subject of the first article I ever published nearly 22 years ago: The Perils of Investor Overconfidence. It has stood the test of time well – I wouldn't change a word. Excerpt:
The topic I'd like to discuss today is behavioral finance, which examines how people's emotions affect their investment decisions and performance. This area has critical implications for investing; in fact, I believe it is far more important in determining investment success (or lack thereof) than an investor's intellect. Warren Buffett agrees: "Success in investing doesn't correlate with I.Q. once you're above the level of 25. Once you have ordinary intelligence, what you need is the temperament to control the urges that get other people into trouble in investing."
Numerous studies have shown that human beings are extraordinarily irrational about money. There are many explanations why, but the one I tend to give the most weight to is that humans just aren't "wired" properly. After all, homo sapiens have existed for approximately two million years, and those that survived tended to be the ones that evidenced herding behavior and fled at the first signs of danger – characteristics that do not lend themselves well to successful investing. In contrast, modern finance theory and capital markets have existed for only 40 years or so. Placing human history on a 24-hour scale, that's less than two seconds. What have you learned in the past two seconds?...
For more on this topic, see this 2006 article I published in the Financial Times: The Undermining Effects of Overconfidence.
Best regards,
Whitney
P.S. I welcome your feedback at [email protected].
