David Einhorn recently issued his investor letter for the third quarter, generating media reports concerning the contents. He reportedly compared Tesla to Lehman Brothers (I recently discussed Tesla here). He also went on to discuss his decision to liquidate his Apple (“AAPL”) position. See CNBC story reporting on letter.
Einhorn’s stated reasons for this move, the process and circumstances surrounding this action, as contrasted with those of Buffett’s AAPL investment, led to a couple of observations.
First, I should say that I have little doubt that David Einhorn is a smarter individual and a better investor than I am. As I have shared here before, I think he is one of the truly “legit” hedge fund “titans.” He has performed very well historically, despite all of the usual impediments to outperformance that come with running a large fund of other peoples’ money and the huge headwind of high fees he has to overcome. See Insurers: Greenlight RE and Brighthouse Financial; Greenlight RE.
As has been documented, he is reportedly having a horrible year (and very poor several years). According to the Greenlight RE site, the Greenlight fund(s) managing the GLRE investment portfolio are down (22.3%) through the end of September, 2018. That is obviously terribly painful; especially given the S&P’s continued romp higher.
As I mentioned in the prior pieces about Einhorn, this seems likely to come from his “bubble basket” of shorts and also some turrible performance from some of his longs, like GM and Brighthouse Financial. I personally would not throw in the towel on him solely because of this underperformance. I believe you have to focus on the process of an investor like this, rather than just the performance. Also, you know he’s long value and short momentum, he’s going to get crushed in times of exuberance.
I think that I am, however, concerned based on his decision to sell AAPL. Particularly, one of the stated reasons for this decision seems to reveal things about his process and/or the impact of his investment structure on his decision making process that I personally find unappealing (not to mention having a large gold position).
The Dragon Roars?
Einhorn’s decision to sell AAPL is reportedly attributable (at least in part) to concerns about potential “Chinese retaliation against America’s trade policies.”
First, this seems to me to be the kind of thing that Buffett and Munger would label as “important, but unknowable.” Yes, maybe AAPL’s production in China (or sales) will be severely impacted by Chinese state actions. This would definitely lead to a some horrible quarters. Yet, maybe that would force them to diversify their production or move it to an economy with better protections for private property, perhaps even strengthening the economies which account for the bulk of AAPL’s sales and profits and making its business overall more sustainable for the long term.
Maybe AAPL would move production to Southeast Asia (perhaps Vietnam), helping guide the development of another strong capitalist/democracy and trading partner in the region. What if the approach, over time, helps put China on a more sustainable, balanced path? Maybe Foxconn would move more facilities out of mainland China and the seemingly growing influence of the communists on Taiwan is reduced.
The bottom line is that no one knows if it will happen or what the longer-term impacts of this development (if it even materializes) will be.
Buffett’s Approach
Let’s contrast this with Buffett’s stated approach on AAPL. Here’s an interview where the subject comes up. Basically, he is focused on the question, “Is AAPL likely to sell more products and services and generate more customer satisfaction and cash a decade from now?” Does a trade spat with China, if any, materially impact that in a knowable way?
Whatever your answer to question one, I do no understand how you can have sufficient confidence in your answer to question two to successfully “dance in and out of the stock.” Buffett also has repeatedly stated he would love to buy more AAPL lower. Impacts from a trade spat for a quarter or two (or a year or two) could present just that type of opportunity, assuming his view of the long term prospects for the business do not changed (owing to less transitory considerations). So he is more likely to take these sorts of developments as they come and view them as potential opportunity.
Another Buffett point is relevant. He has said (roughly), anytime someone makes an economic prediction, you have to ask “then what?” Predicting the “second order” impacts from these types of developments seems absurdly difficult. So, I really don’t think this is an area where you want to devote a lot of your focus.
I don’t want to overstate the point here. Einhorn really seems to have pointed to valuation as the primary reason for his move (headlines aside). So maybe he views the trade spat as increased risk to the business, which he doesn’t feel like he’s being compensated for that at this valuation. I suppose that is rational and his investors expect him to make these kind of moves.
One has to consider, however, if he would he be making this move if he did not have to pen a quarterly letter setting forth brilliant moves and sharing the sophisticated justifications. Do you want to bet on anyone’s ability to dance in and out of stocks (generating taxes, fees, and commissions) like this?
As for me, I will definitely still follow him as a source of potential great ideas, but I will need to be very cognizant of the fact that I do not want to be making moves because I have a gain and something may be going on with a trade spat.
In conclusion, I suppose my observation isn’t some startling realization. I have been able to eliminate GLRE from my “watchlist” due to these concerns about structural issues (which hamper almost all active managers).
I also have reinforced my conclusion that Buffett’s structure (where he doesn’t have to justify high fees on a quarterly basis) is very superior to the typical money management arrangement. His structure seems designed to minimize any pressure to justify fees or “dance in and out of stocks.” Buffett may still feel the urge to do it, since he’s human, but he has at least arranged things to remove some of the usual negative incentives to undertake regular transactions and sound smart on a quarterly basis.
This probably helps him to focus both on the long-term prospects for the businesses he owns and the very limited amount of information that is knowable and important (e.g., observations about AAPL customer loyalty or customers leaving IBM proprietary offerings for an on demand “Cloud” service). It all makes it easier to “sit on your ass.”
The structure of BRK, however, is very rare. In the end, I should probably be on alert for similar structures and have a healthy dose of skepticism for more traditional arrangements. The usual set up seems to exhibit a number of features that are likely to really detract from the performance of (even exceptionally talented) money managers over the long term. The treatment of AAPL by these two great investors may be the most recent example of these factors in action.