Michael Burry – Don’t Be Seduced By Too-Good-To-Be-True Higher Yield Investments

Johnny HopkinsMichael BurryLeave a Comment

One of the best investing resources are Michael Burry’s MSN 2000/2001 Strategy Lab articles where he provides some great insights into his investing strategy. Value investor Burry was the founder of the hedge fund Scion Capital, and he was one of the first investors to recognize and profit from the subprime mortgage crisis. The story of which was told in the 2015 movie – The Big Short.

Burry was a big believer in preserving capital and avoiding permanent loss saying, “It is a tenet of my investment style that, on the subject of common stock investment, maximizing the upside means first and foremost minimizing the downside. The deleterious effect of permanent capital loss on portfolio returns cannot be overstated.”

One Strategy Lab article which should be of particular interest to all investors is titled – Don’t Worry About Indexes. Worry About Your Stocks, in which he provides some warnings to investors on chasing yields and trying to guess the direction of markets. He also provides his thoughts on which stocks ought to do best regardless of the future. Here’s an excerpt from that article:

Brace for yet another new paradigm. Welcome to Round 7 of Strategy Lab. The strategy entry pieces together outtakes from the quarterly letters I write to Scion Capital’s investors.

The cumulative return of my picks over the previous two discontinuous rounds has been just over 23%. Over the same 14-month span, the S&P 500 ($INX) returned a cumulative -22%, and the Nasdaq ($COMPX) returned a cumulative -58%. While the relative performance looks respectable, I am not happy with the absolute performance.

It is not generally true that my portfolios correlate with the various indices anyway, and I know I could have done better with my stock picking here within Strategy Lab. Last round’s performance was particularly harmed by my special situation airline and hotel holdings. I will attempt to do better here this round.

The yield chase.

The need for yield has been apparent in the new issue bond markets of late. The Ford deal was doubled in size even as Ford made it clear that the company would be lending out at 0% that which it borrows. Stocks don’t pay dividends anymore, savings and money market accounts yield too little. The remaining option is bonds. To the degree the need for yield results in a mass panic for yield, however, the consequences will be dire.

While earnings yields on equities are commonly mispriced, bond yields are much less commonly mispriced. So what is my recommendation to those who approach me in search of higher yields? Caveat emptor. In other words, work hard not to be seduced when a too-good-to-be-true higher yield investment comes along.

Moreover, should deflation become a factor, the tremendous debt burden under which many U.S. companies and consumers operate will become much more of a burden, even as consumers hold off on consumption as they wait for lower prices.

Forecasting the direction of markets and which stocks ought to do well regardless of the future.

Paradigms are continually turned upon their heads. This is how the United States as a country progresses. We ought brace for yet another new paradigm — one that few if any pundits including me — can predict.

Regardless of what the future holds, intelligent investment in common stocks offer a solid route for a reasonable return on investment going forward. When I say this, I do not mean that the S&P 500, the Nasdaq Composite or the market broadly defined will necessarily do well. In fact, I leave the dogma on market direction to others. What I rather expect is that the out-of-favor and sometimes obscure common stock situations in which I choose to invest ought to do well. They will not generally track the market, but I view this as a favorable characteristic.

You can read all of Burry’s MSN 2000/2001 Strategy Lab articles here.

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