Embarrassing John Bogle quote about Michael Burry

[fredflinstone]

Sorry if this has been posted before. From http://www.centaurcapital.com/docs/041003.html:

Forbes magazine had less-kind things to say about hedge funds back in July 2001 in an article called "The $500 billion Hedge Fund Folly." Their conclusion then was that "hedge funds soak you with high fees and under-perform the market." In the 2001 article, Forbes proposed the following as a working definition of a hedge fund: "A hedge fund is any investment company that is unregulated, has limited redemption privileges, and charges outrageous fees." The author also enlisted the help of John Bogle, the Vanguard index fund czar, to make the case against hedge funds. Bogle obliged, noting that it is not realistic for investors to expect the hedge fund industry of more than 6,000 funds and $500 billion in assets to outperform the rest of the market over the long term.

This is a reasonable observation, and I don't necessarily disagree with him. Unfortunately, he then went on to pick a name at random from a hedge fund directory to disparage, saying: "I don't know what to do about Scion Capital, started by Michael Burry M.D. after leaving his third year of residency in neurology. He started it mostly with his own money, $1.4 million, and he's looking for more. His technique to manage risk is to buy on the cheap and, if he takes a short position -- I hope you're all sitting down for this -- it is because he believes the stock will decline."

Essentially, Bogle was belittling Michael Burry because (a) Burry had no formal training in finance and (b) Burry had attracted almost no investment money when he started up his hedge fund.

But Bogle picked the wrong guy to ridicule.

Michael Burry, as readers of Michael Lewis' The Big Short know, went on to become an incredibly successful hedge fund manager who outperformed the S&P index by nearly 250-fold between November 2000 and June 2008. (And, no, that is not a typo. His fund was up 489 percent during that period net of fees and expenses vs. a rise of 2 percent for the S&P.) He is most famous for correctly predicting (and betting on) the demise of subprime mortgage bonds.

My takeaway lesson is that there are a small number of superb investors out there who can consistently beat the market. Michael Burry is one. Warren Buffett is another. Unfortunately, retail investors cannot identify such money managers except in retrospect; thus we are better off using index funds.

[Ever Ready]

Mr. Bogle unwittingly proved the point. He picked Burry as his target of criticism, because he felt Bury would fail due to his lack of training and capital.

He accidently picked a successful manager by trying to pick a failure. Most investors will end up picking a failure by trying to predict success.

[wannabe_CPA]

Nah, it's more like there's a handful of people who are extremely lucky, which by all rights there have to be. Someone has to be in the tail, after all.

See this Burry character is probably pretty sharp and a lot smarter than I am. He probably has figured out some market signal that has worked up to this point. Truly he's lived the fantasy that a non financial professional just needs to roll up his sleeves and make the right calls (or puts, in some cases...) and make a fortune in the market. It's the American dream and he's lived it let's all get on board and do the same right?

Well in all seriousness good for him. The fact is though that there are people who do actively invest successfully is completely useless to me, because there's no way to objectively discover them at the beginning of their run of good fortune. Most of the time they aren't as wildly successful as Burry, and by the time you pay the costs associated with their strategies you might as well have been a boring passive investor.

In a former life I was a mathematician who played with topology and calculus and other esoteric lore, and one thing I learned is that very sophisticated and intelligent people use math to prove up all sorts of models that are only as valid as their underlying assumptions. The trouble is, how do you tell when the underlying assumptions are still valid? One of the cornerstones of mathematics is that statements are usually only true or valid within limits. On paper, in the world of theory, it's often possible to find those limits (unless some kind of incompleteness issue arises, which is yet another wrinkle). But when that theory attempts to model reality, well, I have to wonder what unknown factor is going to come along and throw the model off and when.

Burry's kind of performance just isn't sustainable at some point. A 250 percent return in 10 years would turn a million dollars into two and a half million correct? In a century it would be 2,560 million, and in two centuries it would be over 2,621,440,000,000, and in three centuries... well the government would to print even more money, if some kind soul could check my off the cuff arithmetic. But I'm being ridiculous, clearly this hedge fund will not operate for that long in all likelihood and it's equally ridiculous to assume this return will continue indefinitely, which is actually my point. However we don't know that, and that's the problem. We have no idea when to get in or get out or how long his model or method will work.

And there are all sorts of people making all sorts of predictions every day; somebody has to be right eventually. I could make some right now and I bet they'd seem reasonable and solid to at least somebody. Better yet I could write vague and metaphorical quatrains and be famous in four centuries.

That someone outperforms some benchmark for X number of years is no more or less extraordinary than flipping a quarter and getting heads X number of times. Granted, a particular individual may be using a weighted quarter with a greater than 50% chance of heads, but the analogy holds.

But I agree that it's not a good thing to ridicule people for their investment strategies and decisions. It's far better to wish them luck and if pressed explain why you won't partake in their enterprise. It's sad to learn John Bogle is human and misspeaks sometimes but there you are.

Some of the smartest people I know who actually live off their portfolio income and whom I respect would never, ever use a Bogle-esque strategy. I'm personally happy just trying to be average and take whatever return the market offers on any given asset class and not worry about it, but some people just can't do that. Then again I'm lousy at poker, refuse to buy lottery tickets, and I don't bet on horse races either.

[cjking]

Burry's kind of performance just isn't sustainable at some point.

He's become famous for exploiting a particular opportunity. Obviously there isn't a conveyor belt of similar opportunities, so you're refuting a claim that nobody is making.

I don't believe his success is mainly due to luck. Anyone who can get an investment bank to invent the products he needs, to exploit an opportunity virtually no-one else saw, deserves our respect.

I agree his success should have no implications for how we all invest.

[Random Musings]

IMHO, the most important concepts to take from the article are:

Their [Forbes] conclusion then was that "hedge funds soak you with high fees and under-perform the market." In the 2001 article, Forbes proposed the following as a working definition of a hedge fund: "A hedge fund is any investment company that is unregulated, has limited redemption privileges, and charges outrageous fees." The author also enlisted the help of John Bogle, the Vanguard index fund czar, to make the case against hedge funds. Bogle obliged, noting that it is not realistic for investors to expect the hedge fund industry of more than 6,000 funds and $500 billion in assets to outperform the rest of the market over the long term.

Plus, don't try to pick losers (or winners) to a benchmark. Kinda like flipping coins adjusting for embedded costs.

RM

[fishndoc]

Mr. Bogle unwittingly proved the point. He picked Burry as his target of criticism, because he felt Bury would fail due to his lack of training and capital.

He accidently picked a successful manager by trying to pick a failure. Most investors will end up picking a failure by trying to predict success.

I disagree; spectacular success is not always by chance. There are a few people among us with unique abilities - most of the time chance does not allow them the opportunity to use their gift, but occasionally they are in the right place at the right time to exploit their ability in spectacular fashion.

Maybe an even better example than Burry is Andrew Lahde: after his hedge fund returned something in the neighborhood of 1,000% in 2007 betting against subprime mortgages, he followed with a move that was even smarter: he quit.
HIs resignation letter is a classic:

October 17, 2008
Today I write not to gloat. Given the pain that nearly everyone is experiencing, that would be entirely inappropriate. Nor am I writing to make further predictions, as most of my forecasts in previous letters have unfolded or are in the process of unfolding. Instead, I am writing to say goodbye.

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, “What I have learned about the hedge fund business is that I hate it.” I could not agree more with that statement. I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy only ended up making it easier for me to find people stupid enough to take the other side of my trades

http://www.ft.com/cms/s/0/128d399a-9c75 ... s01=1.html

[3CT_Paddler]

Maybe an even better example than Burry is Andrew Lahde: after his hedge fund returned something in the neighborhood of 1,000% in 2007 betting against subprime mortgages, he followed with a move that was even smarter: he quit.
HIs resignation letter is a classic:

October 17, 2008
Today I write not to gloat. Given the pain that nearly everyone is experiencing, that would be entirely inappropriate. Nor am I writing to make further predictions, as most of my forecasts in previous letters have unfolded or are in the process of unfolding. Instead, I am writing to say goodbye.

Recently, on the front page of Section C of the Wall Street Journal, a hedge fund manager who was also closing up shop (a $300 million fund), was quoted as saying, “What I have learned about the hedge fund business is that I hate it.” I could not agree more with that statement. I was in this game for the money. The low hanging fruit, i.e. idiots whose parents paid for prep school, Yale, and then the Harvard MBA, was there for the taking. These people who were (often) truly not worthy of the education they received (or supposedly received) rose to the top of companies such as AIG, Bear Stearns and Lehman Brothers and all levels of our government. All of this behavior supporting the Aristocracy only ended up making it easier for me to find people stupid enough to take the other side of my trades

http://www.ft.com/cms/s/0/128d399a-9c75 ... s01=1.html

Great quote there! I think this is a great example of the statement by Graham, "In the short run, the market is a voting machine, but in the long run it is a weighing machine." In the short term the market (majority of capital) thought that housing would continue to rise and in the very least would not decline in value, but a couple knowledgeable people were able to exploit that false belief. It was a unique opportunity that a couple people took advantage of... I don't know if I would call that pure luck. Maybe the next big fallacy is the safety of government bonds? I sure don't know... I will stick with the tried and true Boglehead wisdom.

[gw]

He made one big bet, and he won big. Maybe he's a genius, or maybe he got lucky like the guy who takes one shot at the roulette wheel. Or maybe something in between. Anyway, let's revive this thread after we see his next ten years of returns.

Oops, nevermind---he shut down his fund....

[LTAccumulator]

I agree with GWs above post. I do give the doc credit for having the conviction to make his bet big.

[taemoo]

From what I've read about Michael Burry in vanity fair, I think he's more than lucky. He's a genius who does extensive research. He's had positve returns in the last 2 recessions so it's just more than this housing call.

[wannabe_CPA]

He's become famous for exploiting a particular opportunity. Obviously there isn't a conveyor belt of similar opportunities, so you're refuting a claim that nobody is making.

I'm not refuting anything other than "My takeaway lesson is that there are a small number of superb investors out there who can consistently beat the market". Emphasis on the word "consistently". Burry is by no means unique and if it appears I was singling him out, I wish to clarify I was not.

If you have a market that provides variable returns, over time, some participants wind up at the extremes of extreme loss and extreme gain. I'd bet none of the big "losers" ever get any publicity, and that very few of them were just stupid or reckless. They probably had every reason to believe their method was going to work.

I don't believe his success is mainly due to luck. Anyone who can get an investment bank to invent the products he needs, to exploit an opportunity virtually no-one else saw, deserves our respect.

Preparation + Opportunity = Success.

I admire the preparation component but the opportunity component does not impress me as much. It's just a clear example of a smart man exploiting something he lucked into, however sophisticated it may have been.

I have a friend who right now is trying to position himself in derivatives in stocks for companies that have anything to do with cloud computing. He has read a lot, and I mean a lot, of research on this and believes he knows exactly when this will take off, how it will move, etc. His analysis is very sophisticated and well thought out with some well established models. I can admire his capability for being able to gather and implement all this information. Why aren't we lauding his genius?

Because if it works out for him, it's just pure luck. Being who he is, if it falls flat, and it probably will, he'll move on to something else until he finds success. Burry just found his success in the hedge fund.

I agree his success should have no implications for how we all invest.

Indeed.

[Wonk]

It's tough for me to put Buffett and Burry in the same class of investor. Buffett has been doing his thing for 40-some years while Burry is a recent phenomenon.

Not to disparage Burry's success--it's admirable. But one similarity between the two is striking to me: conviction to not diversify.

Buffett believes diversifying investments is good only for those who don't know how to evaluate and buy businesses. That would mean most of us, which I'm sure we can all agree with.

Like Buffett, Burry did his homework, connected the dots and placed a massive bet on what he believed to be the only outcome of subprime. He was right, not lucky.

There's a big difference between being one of the few individuals with the rare combination of intelligence, hard work, insight and resources versus placing a blind bet on a roulette table.

[neverknow]

..

[VictoriaF]

I find the title of this thread distasteful.

Victoria

[Beagler]

A few points:

(1) neurology training never stopped anyone from being a knowledgeable, successful investor. Just ask Dr. William Bernstein.

(2) it never ceases to amaze me the lengths that some people will go to "explain away" non-indexing financial success. The fact that some people are truly skillful (and not just lucky) seems to really, really, really bother some people.

(3) there will always be some people who are on the ground floor of a successful fund. They will do well. Few investors will have this opportunity. Few people will also become astronauts. Few people will play for the NBA. Relatively few people will perform at Carnegie Hall. But some will, and it's poor sportsmanship to begrudge them that success.

(4) Mr. Bogle said what he said. If some don't like the fact that history turned out the way it did, well, sorry.

[dumbmoney]

Mr. Bogle is such a good investor that he can't pick a bad fund even when he tries.

[tadamsmar]

IMHO, the most important concepts to take from the article are:

Their [Forbes] conclusion then was that "hedge funds soak you with high fees and under-perform the market." In the 2001 article, Forbes proposed the following as a working definition of a hedge fund: "A hedge fund is any investment company that is unregulated, has limited redemption privileges, and charges outrageous fees." The author also enlisted the help of John Bogle, the Vanguard index fund czar, to make the case against hedge funds. Bogle obliged, noting that it is not realistic for investors to expect the hedge fund industry of more than 6,000 funds and $500 billion in assets to outperform the rest of the market over the long term.

Plus, don't try to pick losers (or winners) to a benchmark. Kinda like flipping coins adjusting for embedded costs.

RM

I am not sure Burry's fund even met that definition of "hedge fund". I think his routine fees were zero. He only took a fee from gains.

[tms]

From what I read about Burry, he sounds like a true genius, a freak of nature...incredible ability to focus, see patterns, and do it all in his spare time with no sleep.

[Random Musings]

tadamsmar wrote:

I am not sure Burry's fund even met that definition of "hedge fund". I think his routine fees were zero. He only took a fee from gains.

Perhaps that is, but that doesn't take away from the comments about hedge funds in general.

IMHO, a 2 and 20 and 0 and 20 are both hedge funds since they carry a performance fee. But the "pure" definition typically does say that hedge funds also have management fees. In theory, I guess hedge funds could make them zero or waive them.

But if you read stuff - everyone called Scion Capital LLC a hedge fund. His tactical shift from being a value investor until 2005 and then basically shorting subprimes in the fund illustrates what a hedge fund can do - basically anything.

RM

[Lauren Vignec]

Hello Everyone,

I don't know.

When I read Bogle's quote about Burry, before I got to the part about Burry's success, I thought Bogle was complimenting Burry. I thought that this was going to be an article about how Burry had crashed and burned, and here Bogle had complimented a hedge fund manager who went belly-up.

The reason I thought Bogle was complimenting Burry is because without speculators who speculate with their own money, the market cannot be efficient. And if you are going to pick stocks or short stocks, there really doesn't need to be any greater logic than that you pick stocks you think are cheap and short stocks you think will go down.

Anyone who gives a fancier justification than that is just blowing smoke anyway.

We need some speculaters. I'm just not sure that we need speculaters who speculate with other peoples' money--certainly, the market could be efficient without them. At best they just add noise.

Anyway, maybe Bogle meant to ridicule Burry. If I were going to ridicule a hedge fund manager (and I'm certainly not above ridiculing the ridiculous) I'd pick someone who was using leverage and speculating with other peoples' money.

L

[tadamsmar]

If I have the numbers correctly, Burry's bet would have gone flat if housing prices had increased 1% or so per year between 2001 and 2007.

He would have had a loss on his bond insurance bet and we would have never heard of the guy. Not a relatively huge loss, but it might have put him out of business given that he already had an investor revolt.

He was subject to the usual problem with guessing when a bubble will burst, but his exposure on the downside was not too great.

[newbie001]

A few points:

(1) neurology training never stopped anyone from being a knowledgeable, successful investor. Just ask Dr. William Bernstein.

(2) it never ceases to amaze me the lengths that some people will go to "explain away" non-indexing financial success. The fact that some people are truly skillful (and not just lucky) seems to really, really, really bother some people.

(3) there will always be some people who are on the ground floor of a successful fund. They will do well. Few investors will have this opportunity. Few people will also become astronauts. Few people will play for the NBA. Relatively few people will perform at Carnegie Hall. But some will, and it's poor sportsmanship to begrudge them that success.

(4) Mr. Bogle said what he said. If some don't like the fact that history turned out the way it did, well, sorry.

Very good post. Point #2 is especially true. The mental gymnastics some people engage in to write-off managers who made very shrewd bets is puzzling.

[droliver]

I'd suggest everyone read "The Big Short" featuring Dr. Burry.

He made a very insightful observation that the emperor had no clothes and was right. Keep in mind that he's only famous now because he managed to stay solvent longer then the market stayed irrational. If things had stayed on track for longer then he'd guessed, he would have busted and had masive withdrawls from his hedge fund at first chance. His investors were furious at where he'd tied their money up (they'd assumed he was continuing to be a value stock picker & not a previously unheard of "CDS speculator").

A singular event like this proves little other then how unlikely it is to think it could be replicated by someone.

[matt]

I encourage the skeptics who say that Burry just got lucky on his timing to read his letter to investors from 4Q 2006. http://scioncapital.com/PDFs/Scion%2020 ... %20FAQ.pdf

Particularly, this section at the top of page 4 lays out the issue of timing.

Most of these subprime mortgage pools will likely see maximum foreclosures a little over two years into the life of the pool. The reason is that most subprime mortgages included in these pools – typically 80% of the mortgages in the pools – are adjustable rate mortgages. As a result, the mortgage pool will experience its most significant stress when the initial teaser rate period ends on its set of adjustable rate mortgages. Generally, this period ends on average 20-24 months from the date of issuance of the mortgage pool.

Since the Funds shorted mortgage pools mostly originated in spring through late summer 2005, I expect the pools shorted will see maximum stress during the latter half of 2007. No one shorting these tranches would expect to see a payoff during the first year of holding the short and likely not even during the second year. In fact, the apparent credit support under each rated tranche will grow during the first year or two. If the thesis plays out as originally contemplated, the reduction in credit support and ultimately the payouts on credit default swaps would come shortly after the mortgage pools face their peak stress, or roughly 2-2.5 years after deal issuance.

Burry had very good reason to believe that defaults would soar in late 2007. Remember, the housing market had already peaked at the time he was writing this. So the explicit assumption he made was that the housing market would remain soft and not jump back into high gear. A collapse in nationwide home prices was not required for his short position to make money, though it certainly increased the gains. All that was required for him to succeed was that homeowners who bought at peak prices with little money down and teaser ARM rates would begin to default when their monthly payments skyrocketed and their was no equity in the home.

So the only case you can make that he got lucky on his timing is if the burst of the housing bubble had been halted in 2006 and reversed to new peaks. Is it possible that could have happened? Perhaps. Certainly that is what most people believed at the time. But mass delusion cannot dictate reality indefinitely. Burry took a calculated risk. Sure, it wasn't guaranteed to work exactly as he expected. But it was the right bet to make based on the expected return (probability of payoff x payoff on success - cost of carry). Even if it had not worked out, I say it was still the right bet.

[droliver]

Matt,

if you read "The Big Short" you will see he actually did get lucky in his timing in the sense that if the crash hadn't started on schedule, his hedge fund would have had massive investor withdrawals and there was language in the contract with his trading partners at the banks that they could reclaim the CDS's at par if Scion Capitals assets fell below $200M. He could just as well been later vindicated but unable to profit from his insight if things had tetered along for awhile.

His desperation and frustration with the banks and bond traders stalling on accurately valuing these vehicles he owned is well described in the book. The bank trying to stall the plumeting of these investments as they realized what they were sitting on was one of the most disturbing things in "The Big Short"

[VennData]

Essentially, Bogle was belittling Michael Burry because (a) Burry had no formal training in finance and (b) Burry had attracted almost no investment money when he started up his hedge fund.

But Bogle picked the wrong guy to ridicule.

Michael Burry, as readers of Michael Lewis' The Big Short know, went on to become an incredibly successful hedge fund manager who outperformed the S&P index by nearly 250-fold between November 2000 and June 2008.

My takeaway lesson is that there are a small number of superb investors out there who can consistently beat the market.

[tadamsmar]

The risks that Burry faced:

1. Housng prices could have just risen modestly for 6 years.

2. The mortgage bond market was thin, it was being manipulated and that might have kept it up for a while after defaults rose.

3. His shareholders were revolting, given a little more time their law suit might have forced him to liquidate before the mortgage bond crash.

4. The feds might have propped up the homeowners. Instead they propped up the investment bankers.

5. The firms that sold him the insurance might have gone bankrupt. Instead, the feds covered their obligations.

[Olav2]

Not to hijack the thread, but I saw this in the paper today. Luck, skill, not sure. But for 30/3% he certainly can't lose!

http://www.washingtonpost.com/wp-dyn/co ... 02802.html