One of the investors we like to follow closely here at The Acquirer’s Multiple is Michael Burry, founder of Scion Asset Management, a company he liquidated in 2008 to concentrate on his own investments.
Burry’s shareholder letters are some of the most insightful for investors. One of the best is his April 2001 letter in which he shares a story which illustrates the mistake that investors make when thinking about volatility and risk, and the loneliness of going against the crowd.
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Here’s an excerpt from that letter:
Because expenses are relatively fixed, higher amounts of assets dilute the expense ratio. Therefore, in keeping with the goal to lower the expense ratio, efforts must be made on occasion to raise new capital. While attempting to raise new capital recently, your manager has recently had a colorful experience that is fairly illuminating with regards to the hallowed ground on which most investors consider volatility.
I delivered a short talk at the Banc of America Alternative Investment Strategies Symposium in Los Angeles last month. I had a good slot – immediately after the keynote speaker and at about 9 o’clock in the a.m. A room of about 200 wealthy potential clients heard me state unequivocally that risk is not defined by volatility, but rather by ill-conceived investment. The corollaries, as I pointed out, were that portfolio concentration and illiquidity do not define risk. That simple statement, I am told, had not just a few of those in the room shaking their heads.
The very pleasant gentleman who spoke after me then proceeded to delineate how frequently his portfolio moved with a magnitude greater than 1% on a daily basis. I think the number was quite impressive for an institution that measures itself by such things – somewhere around 25 days in the past two years or so. And this, he proclaimed, minimized volatility and thus risk. He seemed a decent fellow, and if you wish me to provide his name and number, I would be happy to do so.
Not that he necessarily needs the business. Perhaps it is not so surprising that your portfolio manager sat relatively alone at his lunch table, while the second fellow was quite popular. By and large, the wealthiest of the wealthy and their representatives have accepted that most managers are average, and the better ones are able to achieve average returns while exhibiting below-average volatility.
By this logic, however, a dollar selling for 50 cents one day, 60 cents the next day, and 40 cents the next somehow becomes worth less than a dollar selling for 50 cents all three days. I would argue that the ability to buy at 40 cents presents opportunity, not risk, and that the dollar is still worth a dollar.
The stock market is full of dollars selling for much more than a dollar. A dollar that consistently sells at 1.1X face value may even be respected for the consistency of this quality, earning it the “right” to have that premium.
These are not the investments your portfolio manager chooses for the Fund. A wildly fluctuating dollar selling for 40 or 50 or 60 cents will always remain more attractive – and far less risky. As for my loneliness at the lunch table, it has always been a maxim of mine that while capital raising may be a popularity contest, intelligent investment is quite the opposite. One must therefore take some pride in such a universal lack of appeal.
You can find the entire April 2001 shareholder letter here. (Courtesy of csinvesting.com)
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