In his prime, Julian Robertson was considered to be the godfather of the modernrn hedge fund industry. He started Tiger Management Corp. in 1980 with $8 million in seed capital and built it into a $22 billion hedge fund empire.
For most of the 1980s and 1990s, Robertson’s fund generated annual returnrns in excess of 30%, putting him in the pantheon of investing gods like George Soros and Warren Buffett.
Alas, the late 1990s tech bubble was his downfall… but not for the reasons you might think.
Robertson believed that technology stocks were in a massive speculative bubble, and he avoided the sector.
He was right, of course. But it didn’t matter. His investors lost patience after he underperformed the indexes for a couple years and jumped ship. Bleeding assets left and right, Robertson ended up closing his fund in 2000 and returnrned the money to his investors.
Ironically, Robertson closed up shop right as the bubble was starting to burst. The investors that stuck with him would have likely made really good money in the years that followed.
Another investor whose name you might recognize – a certain gentleman from Omaha named Warren Buffett – also massively underperformed the S&P 500 in the late 1990s. But Buffett, unlike Robertson, lived to trade another day, and went on to have a decade of solid outperformance.
So, why did Buffett’s Berkshire Hathaway survive, while Robertson’s Tiger Management die?
There’s really just one reason: Buffett never had to face redemptions.
Robertson faced the same issue most mutual fund managers face. He was required to give his investors their money back on demand. And when your profit model is based on a growing pool of assets under management, that’s a big problem.
If half of your investors leave, you just lost half your management fee. Yet you still have office rent and analyst salaries to pay, not to mention that house in the Hamptons and a country club lifestyle to maintain.
This is one of the reasons that most mutual fund managers are closet indexers… and chronic underperformers.
It’s too risky for them to make large bets on their high-conviction trading ideas. They can be right on a major market call… but off ever so slightly on the timing… and effectively be out of business.
Their investors are fickle and prone to chase whatever (or whoever) is hot. So most fund managers keep their head down, ape the S&P 500, and keep their fingers crossed that they don’t get fired.
Buffett never had this problem because Berkshire Hathaway isn’t a mutual fund or hedge fund. It’s a holding company.
Investors can – and do – fire Buffett all the time by simply selling their shares of Berkshire Hathaway the way they’d sell any other stock. But Mr. Buffett never has to pull out his checkbook to returnrn capital to those leaving the way a mutual fund or hedge fund manager would.
As Buffett wrote in his 2017 annual letter, which was released last week:
Charlie [Munger] and I never will operate Berkshire in a manner that depends on the kindness of strangers – or even that of friends who may be facing liquidity problems of their own… We have intentionally constructed Berkshire in a manner that will allow it to comfortably withstand economic discontinuities, including such extremes as extended market closures.
Buffett has access to permanent capital via Berkshire Hathaway’s massive insurance and other business operations.
You and I don’t have access to that kind of capital. But we do enjoy Buffett’s freedom to maneuver. The capital in your brokerage account, IRA or 401(k) account is yours, and you can afford to be patient with it.
All investors and all strategies – even those that soundly beat the market over time – will also underperform for stretches. But if you know your model works, you can ride out the rough patches without worrying about going out of business.
The millionaire mutual fund manager in a suit might look like he’s sitting pretty, but his position is a precarious one. In Buffett’s words, he depends on the kindness of strangers. That will generally limit his ability to trade the way he wants… and he’ll end up watering down his performance by essentially copying the S&P 500 or some other benchmark index.
You have no such constraints. Use that to your advantage.