Risk And Portfolio Management Similarities Between Joel Greenblatt And Stanley Druckenmiller by John Huber, Base Hit Investing
I have been busy over the past couple of weeks. My wife gave birth to twins about two weeks ago, and now that I am back in the office, I am catching up on some reading. While we were in the hospital for about a week, I did have some time to do some reading, and I have some comments on two annual reports of current holdings of mine—JP Morgan and Markel—which I may turn into brief posts.
But briefly, I thought I’d share two videos I recently watched of two great investors—one I talk a lot about, and one that I’ve rarely mentioned.
Joel Greenblatt and Stanley Druckenmiller have put together two of the all-time great track records.
Gates Capital Management's ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
Druckenmiller has arguably one of the four or five most impressive track records of all time when you combine CAGR, assets managed, and longevity. If there was an NCAA-style bracket for all-time great investors, he’d probably be a 2 seed, or possibly even snag the final 1 seed spot—he’s that good. He compounded at around 30% annually from 1981 until he retired from active money management in 2010. He started with a few million and was managing tens of billions by the time he retired. He also famously co-managed the Quantum fund with George Soros for a period of time (Druckenmiller actually managed the fund and came up with most of the investment ideas—including the famous British Pound short. Soros was busy traveling around Europe and mostly just provided Druckenmiller with general advice on position sizing and portfolio management).
Druckenmiller generally stays out of the limelight, and rarely gives interviews. There is a chapter on him in New Market Wizards when he was a young manager in 1992, but there isn’t much in the public domain relative to the size of his success. But recently he gave a talk that was very interesting (transcript is here).
He runs a strategy that is very different from my investment approach, but I still find him to be an interesting investor and his talk had a few conceptual things that I think are important for any investor who hopes to achieve significant outperformance over time. In fact, I think there are a few simple, if not overgeneralized reasons for his success.
These are mentioned in the lecture, but I’ll highlight my takeaways here:
- He waits for the fat pitch. I’ll paraphrase something he once said: “the best thing to do is sit around and do nothing, and then when you see something, go a little bit crazy”.
- He is very willing to admit he is wrong (when the facts change, he changes his mind).
- He takes big positions when he finds high probability ideas.
I think these points were a big part of his investment philosophy, and despite his strategy being one that I find difficult to replicate or emulate, I think these concepts had more to do with his success than his ability to analyze macro events, currency movements, or secular trends.
And in fact, those three points are usually exemplified in all the great value investors. Druckenmiller says in the lecture that he really sees no point in watering down your best ideas with marginal ideas just for the sake of diversification. It only will lead to mediocre long term results. He also says something I strongly agree with: there just aren’t that many great ideas. In order to get great results, you have to capitalize on great ideas. And you might only find 1 or 2 or 3 really great ideas in any given year.
It takes patience and discipline to be willing to reject most everything that comes across your plate, and then really capitalize when you locate a high probability idea.
So it’s not much different in terms of philosophy, just the way the philosophy gets implemented: I tend to prefer undervalued high quality businesses that I can easily understand, but Druckenmiller and Soros found an edge by analyzing macroeconomics.
Joel Greenblatt-Different Strategy, Similar Concept, Similar Success
Joel Greenblatt – on the other hand—ran a much simpler (in my opinion) strategy that is much more akin to my own investment approach (thus the reason I mentioned him often and rarely have talked about Druckenmiller).
Joel Greenblatt made 50% annually for a 10 year stretch from 1985-1994 (something not even Druckenmiller and his mentor Soros could match in their famous Quantum fund). Joel Greenblatt and his partner Rob Goldstein then returned outside money, but continued running their own money using the same strategy for another ten years, achieving great results.
Joel Greenblatt’s strategy is nothing like Druckenmiller’s, but there are a few philosophical similarities, namely that Joel Greenblatt tended to put most of his capital into the 5 to 8 best ideas he had at any one time. He felt strongly that beyond this level, diversification didn’t really reduce any additional risk, but did water down results.
There is a case study in Joel Greenblatt’s first book that outlines an average company that was trading for less than liquidation value (or more likely, the value that the business could be sold to a private buyer for). The twist was that the company had a very small retail subsidiary that was growing and had enormous potential. The main business was mundane, lowly profitable, and generally unattractive. The small retail operation was just a small fraction of the overall value, but if the concept worked, it could grow into a much larger piece of the pie—perhaps equaling or exceeding the market value of the entire company.
Joel Greenblatt recognized the growth potential of the growing retail subsidiary, and in fact underestimated the possibilities. But he knew that since he could buy the whole company for less than what the main business could be sold to a private buyer for, he got what amounted to a free call option on the retail business.
Things worked out as planned, and the retail business reported strong growth and Joel Greenblatt subsequently sold when the value and prospects of the retail subsidiary became more recognized.
The case is interesting, but the thing I took away is that Joel Greenblatt said that his favorite ideas consist of finding an investment opportunity where there are very few ways to lose money and multiple ways to win. In the case above: the main business could have been sold, assets could have been liquidated, or maybe the operations could have turned around. And of course, the growing retail business was just gravy. There were multiple “good things” that could happen and very few “bad things”. In fact, I don’t recall exactly how the situation resolved itself, but I think the bad business didn’t really get better. I think assets ended up getting sold and the company more or less closed down the unprofitable line in order to focus on the good business.
The point is that Greenblatt’s favorite ideas were the ones where he felt there was very little chance of losing money—not necessarily the highest potential returns.
In the video below, he emphasizes this point. (By the way, thanks to Joe Koster who posted this video—I found it on his site—and Joe also emphasized this quote, which is a good one):
“My largest positions are not the ones I think I’m going to make the most money from. My largest positions are the ones I don’t think I’m going to lose money in.”
I think that’s a very important thing to consider. Bill Ackman made about 50% last year. His largest position—because of a catalyst that he himself was very much a part of—was a position that had a very, very low probability of causing a permanent capital loss. As it turns out, the investment worked out great—maybe better than Ackman expected, even though they were unsuccessful in achieving the outcome they originally set out to achieve (which was getting Allergan sold to Valeant). Instead Allergan sold itself to a higher bidder and Ackman probably smiled the whole way.
Some people don’t care for Ackman—I’m not particularly fond of big egos myself, but this was a brilliant investment by a very smart manager. Very low chance of losing money. Upside uncertain, but very low downside. Thus the reason Ackman had around a third of his capital in it.
I think both Joel Greenblatt and Druckenmiller, despite running completely different strategies, both were successful in part because they understood the importance of that concept.
Here is the Druckenmiller lecture: great read even for us much more simple minded value investors.
And here is the Joel Greenblatt interview with Howard Marks that I referenced above: