Below is Part 2 of excerpts from an interview with Kingstown Capital Management (Michael Blitzer and Guy Shanon) conducted by the Columbia Business School Graham & Doddsville newsletter publication.
Patience, Volatility, Clients
“The longer we do this, duration of capital and time horizon has actually become more and more of a competitive edge. We’ve always defined the strategy as kind of having a medium-term time horizon, generally one to three years. These securities tend to have larger mispricings. A typical example is a situation that has a known or likely catalyst but unknown timing— you know it will happen sometime in the next three years, but it could be tomorrow or it could be years from now. Given the structure of the hedge fund industry and the structure of capital, this sort of patience becomes harder and harder over time unless you align yourself with long-term capital…Also there is a lot of capital coming out of event-driven strategies, which overlap somewhat with what we do, this is very good for us.”
“In the past twelve years since we started, time horizons have become a lot shorter…you might not fully appreciate the low tolerance for volatility. If you go to some of these large multi-strat funds, time and volatility are very relevant because they’re running massive amounts of capital. In fact, they’ve attracted so many assets because they manage volatility so tightly. If you went to work there as analysts and you drew down a couple of percent in a month, you get stopped out. But then what do you do with that cash? You have to find another trade tomorrow – is that better than staying with the business you owned the day before? It just feeds the volatility.”
“We take the approach that risk and volatility are very different. A lot of the returns that we’ve made have been either averaging down or buying things that were down…One of the approaches of having a longer-term strategy and longer-term capital is that you can withstand those periods of volatility and take a view over a number of years.”
Clients, Time Management
“From the start, we’ve been very conscious of the importance of having the right partners…it is very hard to beat the market and you need help from your structure and partners. You have to match the duration of your capital with your investments. Going back ten years, we’ve turned down money from people that didn’t share this approach. We’ve never had a formal IR effort. You end up with a certain type of partner by way of hiring a professional marketing person…investment philosophy aside, a direct relationship with partners creates more transparency for them and keeps the alignment of interests very close; sometimes having a marketing person between us inserts another agenda into the mix.”
“We’ve gone through periods where, for many years, we didn’t talk to anyone about new capital. We also learned by watching what didn’t work for other funds. But ultimately this has led to a small group of partners who have stuck with us over time. And with less time spent on marketing and investor relations, there is invariably more time spent on investing and the portfolio.”
When To Buy, Sizing, Hurdle Rate
“If it’s a liquid equity, we’re not in a rush to buy it. We’ll have a fully blown research process first. We’ve met with management, interviewed a large number of former employees, done a lot of work on business competitors. We’ll do that before we own it…Credit is different because it’s such a choppy market. Sometimes we’ll own credit when we’re pretty sure it’s good. We’re 90% sure, but we have to take advantage of the liquidity at that moment and then we’ll backfill our work. You also have more structural and legal protections here if you are wrong.”
“A lot of times what we’re doing is averaging down because we own something and it’s the exact opposite of momentum. So we save room to average down…Sometimes we bought something all the way down and we just have to stop. Sometimes we buy something and it goes up 50% and it was small, because we never got the chance to make it big. Both bad scenarios. After doing it for a while, we just assume it all averages out. We’re not going to own something unless there’s some reason to think it’s really misunderstood or really overlooked, and we are confident the market is wrong, that’s the bottom line…You have to use valuation as an anchor…Joel Greenblatt used to say that it’s more binary. Things are either cheap or they are not. And if its cheap you should just buy it. If you can make a lot of money and you have a significant hurdle that you’re reaching for, it should be pretty clear…that doesn’t mean you never can lose.”
Hedging, Exposure, Shorting
“Our short exposure is generally zero to 25%. The majority of our hedging is where we think we can isolate industry risk. We want to be very specific, we’re not looking to hedge the volatility of a particular name. We’re looking to tease out some exposure that may worry us. Usually you can’t do it, that’s why we don’t do a lot of them.”
“…unlike a long-short fund, where you’re under constant pressure to maintain a certain short exposure, we don’t have to keep loading the short book with God knows what. If we think something is ridiculous and we’re trembling with greed, we’ll do it. Otherwise, we’ll just do nothing.”