Showing posts with label Michael Burry. Show all posts
Showing posts with label Michael Burry. Show all posts

Saturday 17 December 2011

Michael Burry’s 4 Must Read Investing Books


The Big Short by Michael Lewis featured the stories of the first individuals to bet against the US housing market before the 07/08 financial crisis. Michael Burry was said to be the first to do so.


Not only was Michael (Mike) Burry said to have been one of the first to do so, he was also one of the most dogmatic in his approach.
Michael Burry - Scion Capital - The Big Short
Michael Burry's 4 must read investment books
Originally a doctor, Michael Burry spent countless hours learning to be a stock market investor by writing a stock market blog and investing himself  throughout the late 90′s and early 00′s. By the end of decade, he would be the instigator of billions of dollars of bets against the US housing market.
An intriguing character in the book who also turned an original $100,000 in his Scion Capital hedge fund into hundreds of millions, I spent some time trying to find excerpts from his early blog and forum posts.
One of the excerpts (including the 4 books he recommends to all those new to investing) is below:
Re: books
To get started, I’d suggest the following four books:
If you read these books thoroughly and in that order and never touch another book, you’ll have all you need to know. Another book you might want to consider is Value Investing made easy by Janet Lowe – a quick read. I have a fairly extensive listing of books on my site, with my reviews of them, and links to purchase them at amazon [Michael Burry's site no longer live].
My problem is I’ve read way too much. One book stated, “If you’re not a voracious reader, you’ll probably never be a great investor.” But sometimes I wish I had a more focused knowledge base so that my investment strategy wouldn’t get all cluttered up.
Re: Security Analysis (Graham and Dodd) you can get a lot of the same info in a more accessible format elsewhere, but everyone says that Buffett’s favorite version is the 1951 edition. Yes there are differences, and the current version has a lot of non-Graham like stuff in it.
Good Investing,Mike
For a full list of his comments and posts, you can visit this Michael Burry profile on Silicon Investor.  http://www.siliconinvestor.com/profile.aspx?userid=690845




Michael Burry Profiled: Bloomberg Risk Takers

http://bloom.bg/oTqnej#ooid=AydDFvMjqk2DszwdQhDSgt4DJn280PSc


Michael Burry Profiled: Bloomberg Risk Takers

    July 20 Bloomberg) -- "Bloomberg Risk Takers" profiles Michael Burry, the former hedge-fund manager who predicted the housing market’s plunge. He forecast that the bubble would burst as early as 2007, and he acted on his conviction by betting against subprime mortgages. The former head of Scion Capital LLC was profiled in Bloomberg columnist and bestselling author Michael Lewis' book "The Big Short". (Source: Bloomberg)


Sunday 23 January 2011

Michael Burry: Money managers typically get paid simply for amassing vast amounts of other people's money under their management.

Lessons from subprime to make a money manager squirm
MICHAEL EVANS
January 22, 2011

AS THEY devoured their holiday reading over summer, Australia's fund managers could not have failed to miss the name Mike Burry.

Burry is a doctor who stumbled into investing by writing a blog in the wee hours after his hospital shift that so impressed professional investors that they gave him the money to start his own fund.

He spent hours poring over financial accounts looking for an investment idea. And when he found it, he bet against the entire market, punting that the US subprime housing market was unsustainable. He bet millions and then waited - even after his own investors began to fret and started demanding their money back.

As one of the key figures in Michael Lewis's account of the origins of the subprime crisis, The Big Short, Burry's tale is one every money manager dreams about: spot a fundamental flaw in the market, invest your clients' money, hold your nerve when they panic and prove them wrong by making them hundreds of millions - plus a cool hundred million for yourself.

But as Australia's fund managers dragged their heels back to work this week, they would have taken less delight in another of Lewis's tales about Burry.

When he started his business, Burry disapproved of the typical manager's fee structure. Money managers typically take a slice of their total assets under management, meaning they get paid simply for amassing vast amounts of other people's money. As Lewis wrote, Burry's Scion Capital charged investors only its expenses, which typically ran well below 1 per cent of the assets. To make the first nickel for himself, he had to make investors' money grow.

''Think about the genesis of Scion,'' says one of his early investors. ''The guy has no money and he chooses to forgo a fee that any other hedge fund takes for granted. It was unheard of.''

It's the kind of news to make Australia's money managers shift uncomfortably in their seats. After all, waiting for them when they arrived back at work this week, they were greeted with a scorecard of their 2010 performance that showed that as a group they had a poor year. Investors were left wondering why they paid professionals to grow their savings given the median fund in the Mercer scorecard showed it had lagged the S&P/ASX 300 Index.

Surely investors who simply followed the benchmark themselves would have come out ahead of the median investor in Mercer's annual scorecard? And they wouldn't have paid fees.

But money managers are quick to point out that one year is too short a time to judge their efforts. Paul Fiani's Integrity Investment Management, for example, posted a three-year performance better than many other fund managers who had a stronger 2010 than he did. Over three years, Integrity is just outside the top 10 on the scorecard of more than 130 funds.

Fiani says many gains last year were made at the risky end of the market.

''Last year was all about small resources. The market was basically flat and, overall, small resources were up 30 per cent. So, if you weren't at the high-risk end of the market you lagged the benchmark. We run a pretty rigorous fundamental value investment process and there's no way you could justify being invested in that high-risk end.''

Managing client expectations is tough for money managers. Quarterly and yearly report cards add to the pressure, particularly when investors are told to invest for the medium and long term. As the world enters a low-growth phase that experts expect to last for five to 10 years as the debt hangover plays out, investors may have to adjust their hopes.

Simon Marais, who managed the best-performed fund last year at Orbis, says the importance of individual stock-picking will rise because of low global economic growth.

But what about fund managers being asked to manage their expectations? Australia's investment community enjoys a weekly flow of 9 per cent of every worker's salary into the superannuation pie that helps grow funds under management. And, remember those fees based on funds under management?

Michael Lewis was brutal passing judgment on Wall Street money managers who were being paid to manage investments but did not see the looming subprime disaster: ''What are the odds that people will make smart decisions about money if they don't need to make smart decisions - if they can get rich making dumb decisions? The incentives on Wall Street were all wrong; they're still all wrong.''

Investors rely on the experts. They are willing to pay to have an expert make decisions for them. But given the structure of the system - and the constant drip of compulsory super payments - what are the consequences of bad decisions? Not enough emphasis is placed on performance-based reward.

Aligning the interests of fund managers and investors says, ''my dinner is riding on your success too''.

This week the Australian Prudential Regulation Authority released figures showing retail super funds posted sharply lower returns than average for the sector over the past decade. And when taking inflation into account, many have gone backwards over that time.

The introduction of plain vanilla products into the retail market as a result of the Cooper super review will provide a benchmark in coming years on how they perform against active funds run by the big boys.

Cutting fees like Mike Burry may not make money managers heroes in the eyes of the industry. But if they followed his lead their images would rise a notch or three in the eyes of investors.

http://www.smh.com.au/business/lessons-from-subprime-to-make-a-money-manager-squirm-20110121-1a036.html

Related:
Learning from Michael Burry: from being a medical resident to being regarded as one of the greatest investors in recent history.

Betting on the Blind Side

Saturday 17 April 2010

Goldman Sach and CDOs: Banks Bundled Bad Debt, Bet Against It and Won


December 24, 2009

Banks Bundled Bad Debt, Bet Against It and Won



In late October 2007, as the financial markets were starting to come unglued, a Goldman Sachs trader, Jonathan M. Egol, received very good news. At 37, he was named a managing director at the firm.

Mr. Egol, a Princeton graduate, had risen to prominence inside the bank by creating mortgage-related securities, named Abacus, that were at first intended to protect Goldman from investment losses if the housing market collapsed. As the market soured, Goldman created even more of these securities, enabling it to pocket huge profits.

Goldman’s own clients who bought them, however, were less fortunate.

Pension funds and insurance companies lost billions of dollars on securities that they believed were solid investments, according to former Goldman employees with direct knowledge of the deals who asked not to be identified because they have confidentiality agreements with the firm.

Goldman was not the only firm that peddled these complex securities — known as synthetic collateralized debt obligations, or C.D.O.’s — and then made financial bets against them, called selling short in Wall Street parlance. Others that created similar securities and then bet they would fail, according to Wall Street traders, includeDeutsche Bank and Morgan Stanley, as well as smaller firms like Tricadia Inc., an investment company whose parent firm was overseen by Lewis A. Sachs, who this year became a special counselor to Treasury Secretary Timothy F. Geithner.

How these disastrously performing securities were devised is now the subject of scrutiny by investigators in Congress, at the Securities and Exchange Commission and at the Financial Industry Regulatory Authority, Wall Street’s self-regulatory organization, according to people briefed on the investigations. Those involved with the inquiries declined to comment.

While the investigations are in the early phases, authorities appear to be looking at whether securities laws or rules of fair dealing were violated by firms that created and sold these mortgage-linked debt instruments and then bet against the clients who purchased them, people briefed on the matter say.

One focus of the inquiry is whether the firms creating the securities purposely helped to select especially risky mortgage-linked assets that would be most likely to crater, setting their clients up to lose billions of dollars if the housing market imploded.

Some securities packaged by Goldman and Tricadia ended up being so vulnerable that they soured within months of being created.

Goldman and other Wall Street firms maintain there is nothing improper about synthetic C.D.O.’s, saying that they typically employ many trading techniques to hedge investments and protect against losses. They add that many prudent investors often do the same. Goldman used these securities initially to offset any potential losses stemming from its positive bets on mortgage securities.

But Goldman and other firms eventually used the C.D.O.’s to place unusually large negative bets that were not mainly for hedging purposes, and investors and industry experts say that put the firms at odds with their own clients’ interests.

“The simultaneous selling of securities to customers and shorting them because they believed they were going to default is the most cynical use of credit information that I have ever seen,” said Sylvain R. Raynes, an expert in structured finance at R & R Consulting in New York. “When you buy protection against an event that you have a hand in causing, you are buying fire insurance on someone else’s house and then committing arson.”
Investment banks were not alone in reaping rich rewards by placing trades against synthetic C.D.O.’s. Some hedge funds also benefited, including Paulson & Company, according to former Goldman workers and people at other banks familiar with that firm’s trading.

Michael DuVally, a Goldman Sachs spokesman, declined to make Mr. Egol available for comment. But Mr. DuVally said many of the C.D.O.’s created by Wall Street were made to satisfy client demand for such products, which the clients thought would produce profits because they had an optimistic view of the housing market. In addition, he said that clients knew Goldman might be betting against mortgages linked to the securities, and that the buyers of synthetic mortgage C.D.O.’s were large, sophisticated investors, he said.

The creation and sale of synthetic C.D.O.’s helped make the financial crisis worse than it might otherwise have been, effectively multiplying losses by providing more securities to bet against. Some $8 billion in these securities remain on the books at American International Group, the giant insurer rescued by the government in September 2008.

From 2005 through 2007, at least $108 billion in these securities was issued, according to Dealogic, a financial data firm. And the actual volume was much higher because synthetic C.D.O.’s and other customized trades are unregulated and often not reported to any financial exchange or market.

Goldman Saw It Coming

Before the financial crisis, many investors large American and European banks, pension funds, insurance companies and even some hedge fundsfailed to recognize that overextended borrowers would default on their mortgages, and they kept increasing their investments in mortgage-related securities. As the mortgage market collapsed, they suffered steep losses.

A handful of investors and Wall Street traders, however, anticipated the crisis. In 2006, Wall Street had introduced a new index, called the ABX, that became a way to invest in the direction of mortgage securities. The index allowed traders to bet on or against pools of mortgages with different risk characteristics, just as stock indexes enable traders to bet on whether the overall stock market, or technology stocks or bank stocks, will go up or down.

Goldman, among others on Wall Street, has said since the collapse that it made big money by using the ABX to bet against the housing market. Worried about a housing bubble, top Goldman executives decided in December 2006 to change the firm’s overall stance on the mortgage market, from positive to negative, though it did not disclose that publicly.

Even before then, however, pockets of the investment bank had also started using C.D.O.’s to place bets against mortgage securities, in some cases to hedge the firm’s mortgage investments, as protection against a fall in housing prices and an increase in defaults.

Mr. Egol was a prime mover behind these securities. Beginning in 2004, with housing prices soaring and the mortgage mania in full swing, Mr. Egol began creating the deals known as Abacus. From 2004 to 2008, Goldman issued 25 Abacus deals, according to Bloomberg, with a total value of $10.9 billion.

Abacus allowed investors to bet for or against the mortgage securities that were linked to the deal. The C.D.O.’s didn’t contain actual mortgages. Instead, they consisted ofcredit-default swaps, a type of insurance that pays out when a borrower defaults. These swaps made it much easier to place large bets on mortgage failures.

Rather than persuading his customers to make negative bets on Abacus, Mr. Egol kept most of these wagers for his firm, said five former Goldman employees who spoke on the condition of anonymity. On occasion, he allowed some hedge funds to take some of the short trades.

Mr. Egol and Fabrice Tourre, a French trader at Goldman, were aggressive from the start in trying to make the assets in Abacus deals look better than they were, according to notes taken by a Wall Street investor during a phone call with Mr. Tourre and another Goldman employee in May 2005.

On the call, the two traders noted that they were trying to persuade analysts at Moody’s Investors Service, a credit rating agency, to assign a higher rating to one part of an Abacus C.D.O. but were having trouble, according to the investor’s notes, which were provided by a colleague who asked for anonymity because he was not authorized to release them. Goldman declined to discuss the selection of the assets in the C.D.O.’s, but a spokesman said investors could have rejected the C.D.O. if they did not like the assets.

Goldman’s bets against the performances of the Abacus C.D.O.’s were not worth much in 2005 and 2006, but they soared in value in 2007 and 2008 when the mortgage market collapsed. The trades gave Mr. Egol a higher profile at the bank, and he was among a group promoted to managing director on Oct. 24, 2007.

“Egol and Fabrice were way ahead of their time,” said one of the former Goldman workers. “They saw the writing on the wall in this market as early as 2005.” By creating the Abacus C.D.O.’s, they helped protect Goldman against losses that others would suffer.

As early as the summer of 2006, Goldman’s sales desk began marketing short bets using the ABX index to hedge funds like Paulson & Company, Magnetar and Soros Fund Management, which invests for the billionaire George SorosJohn Paulson, the founder of Paulson & Company, also would later take some of the shorts from the Abacus deals, helping him profit when mortgage bonds collapsed. He declined to comment.

A Deal Gone Bad, for Some

The woeful performance of some C.D.O.’s issued by Goldman made them ideal for betting against. As of September 2007, for example, just five months after Goldman had sold a new Abacus C.D.O., the ratings on 84 percent of the mortgages underlying it had been downgraded, indicating growing concerns about borrowers’ ability to repay the loans, according to research from UBS, the big Swiss bank. Of more than 500 C.D.O.’s analyzed by UBS, only two were worse than the Abacus deal.

Goldman created other mortgage-linked C.D.O.’s that performed poorly, too. One, in October 2006, was a $800 million C.D.O. known as Hudson Mezzanine. It included credit insurance on mortgage and subprime mortgage bonds that were in the ABX index; Hudson buyers would make money if the housing market stayed healthy — but lose money if it collapsed. Goldman kept a significant amount of the financial bets against securities in Hudson, so it would profit if they failed, according to three of the former Goldman employees.

A Goldman salesman involved in Hudson said the deal was one of the earliest in which outside investors raised questions about Goldman’s incentives. “Here we are selling this, but we think the market is going the other way,” he said.

A hedge fund investor in Hudson, who spoke on the condition of anonymity, said that because Goldman was betting against the deal, he wondered whether the bank built Hudson with “bonds they really think are going to get into trouble.”

Indeed, Hudson investors suffered large losses. In March 2008, just 18 months after Goldman created that C.D.O., so many borrowers had defaulted that holders of the security paid out about $310 million to Goldman and others who had bet against it, according to correspondence sent to Hudson investors.

The Goldman salesman said that C.D.O. buyers were not misled because they were advised that Goldman was placing large bets against the securities. “We were very open with all the risks that we thought we sold. When you’re facing a tidal wave of people who want to invest, it’s hard to stop them,” he said. The salesman added that investors could have placed bets against Abacus and similar C.D.O.’s if they had wanted to.

A Goldman spokesman said the firm’s negative bets didn’t keep it from suffering losses on its mortgage assets, taking $1.7 billion in write-downs on them in 2008; but he would not say how much the bank had since earned on its short positions, which former Goldman workers say will be far more lucrative over time. For instance, Goldman profited to the tune of $1.5 billion from one series of mortgage-related trades by Mr. Egol with Wall Street rival Morgan Stanley, which had to book a steep loss, according to people at both firms.

Tetsuya Ishikawa, a salesman on several Abacus and Hudson deals, left Goldman and later published a novel, “How I Caused the Credit Crunch.” In it, he wrote that bankers deserted their clients who had bought mortgage bonds when that market collapsed: “We had moved on to hurting others in our quest for self-preservation.” Mr. Ishikawa, who now works for another financial firm in London, declined to comment on his work at Goldman.

Profits From a Collapse

Just as synthetic C.D.O.’s began growing rapidly, some Wall Street banks pushed for technical modifications governing how they worked in ways that made it possible for C.D.O.’s to expand even faster, and also tilted the playing field in favor of banks and hedge funds that bet against C.D.O.’s, according to investors.

In early 2005, a group of prominent traders met at Deutsche Bank’s office in New York and drew up a new system, called Pay as You Go. This meant the insurance for those betting against mortgages would pay out more quickly. The traders then went to the International Swaps and Derivatives Association, the group that governs trading in derivatives like C.D.O.’s. The new system was presented as a fait accompli, and adopted.

Other changes also increased the likelihood that investors would suffer losses if the mortgage market tanked. Previously, investors took losses only in certain dire “credit events,” as when the mortgages associated with the C.D.O. defaulted or their issuers went bankrupt.

But the new rules meant that C.D.O. holders would have to make payments to short sellers under less onerous outcomes, or “triggers,” like a ratings downgrade on a bond. This meant that anyone who bet against a C.D.O. could collect on the bet more easily.

“In the early deals you see none of these triggers,” said one investor who asked for anonymity to preserve relationships. “These things were built in to provide the dealers with a big payoff when something bad happened.”

Banks also set up ever more complex deals that favored those betting against C.D.O.’s. Morgan Stanley established a series of C.D.O.’s named after United States presidents (Buchanan and Jackson) with an unusual feature: short-sellers could lock in very cheap bets against mortgages, even beyond the life of the mortgage bonds. It was akin to allowing someone paying a low insurance premium for coverage on one automobile to pay the same on another one even if premiums over all had increased because of high accident rates.

At Goldman, Mr. Egol structured some Abacus deals in a way that enabled those betting on a mortgage-market collapse to multiply the value of their bets, to as much as six or seven times the face value of those C.D.O.’s. When the mortgage market tumbled, this meant bigger profits for Goldman and other short sellers — and bigger losses for other investors.

Selling Bad Debt

Other Wall Street firms also created risky mortgage-related securities that they bet against.

At Deutsche Bank, the point man on betting against the mortgage market was Greg Lippmann, a trader. Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.

Deutsche, which declined to comment, at the same time was selling synthetic C.D.O.’s to its clients, and those deals created more short-selling opportunities for traders like Mr. Lippmann.

Among the most aggressive C.D.O. creators was Tricadia, a management company that was a unit of Mariner Investment Group. Until he became a senior adviser to the Treasury secretary early this year, Lewis Sachs was Mariner’s vice chairman. Mr. Sachs oversaw about 20 portfolios there, including Tricadia, and its documents also show that Mr. Sachs sat atop the firm’s C.D.O. management committee.

From 2003 to 2007, Tricadia issued 14 mortgage-linked C.D.O.’s, which it called TABS. Even when the market was starting to implode, Tricadia continued to create TABS deals in early 2007 to sell to investors. The deal documents referring to conflicts of interest stated that affiliates and clients of Tricadia might place bets against the types of securities in the TABS deal.

Even so, the sales material also boasted that the mortgages linked to C.D.O.’s had historically low default rates, citing a “recently completed” study by Standard & Poor’sratings agency — though fine print indicated that the date of the study was September 2002, almost five years earlier.

At a financial symposium in New York in September 2006, Michael Barnes, the co-head of Tricadia, described how a hedge fund could put on a negative mortgage bet by shorting assets to C.D.O. investors, according to his presentation, which was reviewed by The New York Times.

Mr. Barnes declined to comment. James E. McKee, general counsel at Tricadia, said, “Tricadia has never shorted assets into the TABS deals, and Tricadia has always acted in the best interests of its clients and investors.”

Mr. Sachs, through a spokesman at the Treasury Department, declined to comment.

Like investors in some of Goldman’s Abacus deals, buyers of some TABS experienced heavy losses. By the end of 2007, UBS research showed that two TABS deals were the eighth- and ninth-worst performing C.D.O.’s. Both had been downgraded on at least 75 percent of their associated assets within a year of being issued.

Tricadia’s hedge fund did far better, earning roughly a 50 percent return in 2007 and similar profits in 2008, in part from the short bets.



Goldman Sachs Responds to The New York Times on Synthetic Collateralized Debt Obligations
December 24, 2009

Background: The New York Times published a story on December 24th primarily focused on the synthetic collateralized debt obligation business of Goldman Sachs. In response to questions from the paper prior to publication, Goldman Sachs made the following points.

As reporters and commentators examine some of the aspects of the financial crisis, interest has gravitated toward a variety of products associated with the mortgage market. One of these products is synthetic collateralized debt obligations (CDOs), which are referred to as synthetic because the underlying credit exposure is taken via credit default swaps rather than by physically owning assets or securities. The following points provide a summary of how these products worked and why they were created.

Any discussion of Goldman Sachs’ association with this product must begin with our overall activities in the mortgage market. Goldman Sachs, like other financial institutions, suffered significant losses in its residential mortgage portfolio due to the deterioration of the housing market (we disclosed $1.7 billion in residential mortgage exposure write-downs in 2008). These losses would have been substantially higher had we not hedged. We consider hedging the cornerstone of prudent risk management.

Synthetic CDOs were an established product for corporate credit risk as early as 2002. With the introduction of credit default swaps referencing mortgage products in 2004-2005, it is not surprising that market participants would consider synthetic CDOs in the context of mortgages. Although precise tallies of synthetic CDO issuance are not readily available, many observers would agree the market size was in the hundreds of billions of dollars.

Many of the synthetic CDOs arranged were the result of demand from investing clients seeking long exposure.

Synthetic CDOs were popular with many investors prior to the financial crisis because they gave investors the ability to work with banks to design tailored securities which met their particular criteria, whether it be ratings, leverage or other aspects of the transaction.

The buyers of synthetic mortgage CDOs were large, sophisticated investors. These investors had significant in-house research staff to analyze portfolios and structures and to suggest modifications. They did not rely upon the issuing banks in making their investment decisions.

For static synthetic CDOs, reference portfolios were fully disclosed. Therefore, potential buyers could simply decide not to participate if they did not like some or all the securities referenced in a particular portfolio.

Synthetic CDOs require one party to be long the risk and the other to be short so without the short position, a transaction could not take place.

It is fully disclosed and well known to investors that banks that arranged synthetic CDOs took the initial short position and that these positions could either have been applied as hedges against other risk positions or covered via trades with other investors.

Most major banks had similar businesses in synthetic mortgage CDOs.

As housing price growth slowed and then turned negative, the disruption in the mortgage market resulted in synthetic CDO losses for many investors and financial institutions, including Goldman Sachs, effectively putting an end to this market.

http://www2.goldmansachs.com/our-firm/on-the-issues/viewpoint/viewpoint-articles/response-scdo.html

Saturday 27 March 2010

Betting on the Blind Side

Michael Burry always saw the world differently—due, he believed, to the childhood loss of one eye. So when the 32-year-old investor spotted the huge bubble in the subprime-mortgage bond market, in 2004, then created a way to bet against it, he wasn’t surprised that no one understood what he was doing. In an excerpt from his new book, The Big Short, the author charts Burry’s oddball maneuvers, his almost comical dealings with Goldman Sachs and other banks as the market collapsed, and the true reason for his visionary obsession.

April 2010
Dr. Michael Burry in his home office, in Silicon Valley. “My nature is not to have friends,” Burry concluded years ago. “I’m happy in my own head.”


A court had accepted a plea from a software company called the Avanti Corporation. Avanti had been accused of stealing from a competitor the software code that was the whole foundation of Avanti’s business. The company had $100 million in cash in the bank, was still generating $100 million a year in free cash flow—and had a market value of only $250 million! Michael Burry started digging; by the time he was done, he knew more about the Avanti Corporation than any man on earth. He was able to see that even if the executives went to jail (as five of them did) and the fines were paid (as they were), Avanti would be worth a lot more than the market then assumed. To make money on Avanti’s stock, however, he’d probably have to stomach short-term losses, as investors puked up shares in horrified response to negative publicity.

“That was a classic Mike Burry trade,” says one of his investors. “It goes up by 10 times, but first it goes down by half.” This isn’t the sort of ride most investors enjoy, but it was, Burry thought, the essence of value investing. His job was to disagree loudly with popular sentiment. He couldn’t do this if he was at the mercy of very short-term market moves, and so he didn’t give his investors the ability to remove their money on short notice, as most hedge funds did. If you gave Scion your money to invest, you were stuck for at least a year.

..
..

“I have heard that White Mountain would rather I stick to my knitting,” he wrote, testily, to his original backer, “though it is not clear to me that White Mountain has historically understood what my knitting really is.” No one seemed able to see what was so plain to him: these credit-default swaps were all part of his global search for value. “I don’t take breaks in my search for value,” he wrote to White Mountain. “There is no golf or other hobby to distract me. Seeing value is what I do.”

....
....

When he’d started Scion, he told potential investors that, because he was in the business of making unfashionable bets, they should evaluate him over the long term—say, five years. Now he was being evaluated moment to moment. “Early on, people invested in me because of my letters,” he said. “And then, somehow, after they invested, they stopped reading them.” His fantastic success attracted lots of new investors, but they were less interested in the spirit of his enterprise than in how much money he could make them quickly. Every quarter, he told them how much he’d made or lost from his stock picks. Now he had to explain that they had to subtract from that number these & subprime-mortgage-bond insurance premiums. One of his New York investors called and said ominously, “You know, a lot of people are talking about withdrawing funds from you.” As their funds were contractually stuck inside Scion Capital for some time, the investors’ only recourse was to send him disturbed-sounding e-mails asking him to justify his new strategy. “People get hung up on the difference between +5% and -5% for a couple of years,” Burry replied to one investor who had protested the new strategy. “When the real issue is: over 10 years who does 10% or better annually? And I firmly believe that to achieve that advantage on an annual basis, I have to be able to look out past the next couple of years.… I have to be steadfast in the face of popular discontent if that’s what the fundamentals tell me.” In the five years since he had started, the S&P 500, against which he was measured, was down 6.84 percent. In the same period, he reminded his investors, Scion Capital was up 242 percent. He assumed he’d earned the rope to hang himself. He assumed wrong. “I’m building breathtaking sand castles,” he wrote, “but nothing stops the tide from coming and coming and coming.”



http://www.vanityfair.com/business/features/2010/04/wall-street-excerpt-201004?printable=true

Friday 26 March 2010

Learning from Michael Burry: from being a medical resident to being regarded as one of the greatest investors in recent history.

Learning from Michael Burry

If you have ever wanted to learn about Michael Burry, read this post. It is long, but if you feel like skipping what I think, just read the content in the block-quotes, those come straight from Michael Burry of Scion Capital.
Michael Burry of Scion Capital
“you’re a doctor, ipso facto a lousy investor.”
That was one of the first messages Michael Burry received when he started his value investing thread on Silicon Investor, back in 1996. Now however, Burry is a pretty well-regarded investor, having made it big with inventing the credit default swap trade as a means of profiting from the financial crisis and being prominently featured in The Greatest Trade Ever by George Zuckerman and The Big Short by Michael Lewis.
What I wanted to find out is how Burry went from being a medical resident to being regarded as one of the greatest investors in recent history. Burry’s story is pretty inspirational to investment bloggers — he started out in relative obscurity, posting his ideas on message boards and eventually his own site, until he built a strong institutional following. Eventually, his amateur analyst work attracted the likes of Joel Greenblatt’s Gotham Capital and White Mountains Insurance Group (NYSE:WTM). With their money, he started Scion Capital and built a market beating track record. In recent years, Burry unwound his fund in favor of managing his own money.
We are lucky in a way that the internet archives of Burry’s posts are still readily available. These archives let us see how Burry invested and the evolution in his process from about 1996 to 2000. I am sure that his approach changed while he was running Scion as well, but I still think the information here is really insightful to young investors.
1. I’ve read way too much
The first thing that strikes you about Burry is the fact that at the time of his initial post, he has read a lot:
Ok, how about a value investing thread?
What we are looking for are value plays. Obscene value plays.
In the Graham tradition.
This week’s Barron’s lists a tech stock named Premenos, which
trades at 9 and has 5 1/2 bucks in cash. The business is
valued at 3 1/2, and it has a lot of potential. Interesting.
We want to stay away from the obscenely high PE’s and look
at net working capital models, etc. Schooling in the art
of fundamental analysis is also appropriate here.
Good luck to all. Hope this thread survives.
Mike
(Silicon Investor)
Look at the type of value investing that Burry is referring to. Remember, most people mistakenly believe value investing is just copying whatever Warren Buffett does, but value investing is actually more diverse than that. The Graham tradition refers to Benjamin Graham, Buffett’s teacher, and indicates a more quantitative approach to investing. Graham targeted net-nets, stocks trading at 2/3 their net current asset value. He sought hard assets and did not mind investing in terrible businesses as long as the liquidation value was in tact and protected.
Burry later notes that he is an MD, not an MBA. He picked up most of his knowledge by reading. I believe that if you want to be successful in investing, it is important to be willing to learn and explore new concepts on your own.
This must have been especially true for Burry because when he started posting he was just an outsider. He was no Wall Street analyst and lacked the same resources as many institutional investors. But, Burry made up for his lack of professional knowledge with his drive and determination to learn. Here are some of the books he recommended:
Re: books
To get started, I’d suggest the following four books:
The Intelligent Investor by Graham
Common Stocks and Uncommon Profits by Fisher
Why Stocks Go Up and Down By Pike
Buffettology by Buffett and Clark
If you read these books thoroughly and in that order and never touch another book, you’ll have all you need to know. Another book you might want to consider is Value Investing Made Easy by Janet Lowe – a quick read. I have a fairly extensive listing of books on my site, with my reviews of them, and links to purchase them at amazon.
http://www.sealpoint.com/
My problem is I’ve read way too much. One book stated, “If you’re not a voracious reader, you’ll probably never be a great investor.” But sometimes I wish I had a more focused knowledge base so that my investment strategy wouldn’t get all cluttered up.
Re: Security Analysis you can get a lot of the same info in a more accessible format elsewhere, but everyone says that Buffett’s favorite version is the 1951 edition. Yes there are differences, and the current version has a lot of non-Graham like stuff in it.
Good Investing,Mike
(Silicon Investor)
From the period of 1996 to 2000, Burry wrote 3,304 posts or about 2.3 posts per day. He didn’t let the criticism of more experienced investors get to him, on occasion he was lambasted for being a doctor or not a financial professional. But he kept posting anyway. Many of these posts give us a glimpse of his thought process and the kinds of questions he asked. We can see that he mostly used the site as a sounding board to gauge investment ideas and learn from more experienced investors. His constant asking of questions and stock analysis posts are demonstrative of his intellectual curiosity and how he tried to continuously improve his own abilities as an analyst.
2. There’s a way to win at everything. It just has to be found.
If you go back and read Michael Burry’s posting history, you will see that his investment style was influenced by Graham and Buffett but also had a number of unique qualities. Note his use of technical analysis:
As I’ve brought up on this thread before, I was a growth/technical analysis investor for quite a while. I studied TA pretty extensively. Hence, when I felt the market getting toppy last December and became a student of value investing, I found it hard to leave TA completely behind. Mainly I use it only to avoid falling knives and to find buy points at very solid support. I try not to use it to sell stocks
because my horizon remains long-term. With the market this toppy though, I find it hard to ignore when TA says sell after a fast rise. It’s the old take the money and run. It has helped me tremendously, and I have been hurt when I ignore it completely. The four companies I hold now I’m not even charting, though I would do so if one or more gains 40-50% in a few weeks, as WHX has done.
Mike
(Silicon Investor)
Most value investors I think would cringe at the very thought of using TA, but Burry found a way to incorporate it into his approach. Part of this has to do with the fact that he actually starting his trading not in stocks, but in coffee futures:
Jim, I guess I still watch the charts a bit. After all, I cut my teeth trading coffee futures. About 8 trading days ago it broke a significant downtrend on decent volume when it moved to the high 40s. At the point, I wished I had bought more in the low 40s. Today it just popped its 200 day, after trending along it for a few days after trendline breakout. This all occurred in a setting in which the years-long stock chart tested a years-long uptrend and the support held. Maybe TA is only useful because others use it. I don’t know. But it’s interesting to watch, and I believe in it to the degree it reflects crowd psychology. Despite SLOT’s volatility, I’d be surprised if it goes back to sub-50 now.
And yes, I’m waiting for the 80’s at least before I sell, no matter what the chart does. It’s as sure a bet as Apple at 34, Oracle at 23, American Power at 27 (presplit)…
Mike
(Silicon Investor)
Was Burry a futures trading guru? Not quite:
Re: coffee futures, let’s just say I got out with the shirt still on my back.
Mike
(Silicon Investor)
Off-topic
In futures, I learned a lot about TA. The frustrating thing was it worked. You could actually predict the moves. But slippage ate away everything. I was up big at times, never down big. I left with 98% of my original capital as soon as I realized I would have to quit my day job to do it right. The friend that got me into it did quit his day job and is doing ok. There’s a way to win at everything. It just has to be found.
Mike
(Silicon Investor)
We know that right off the bat, Burry had read a number of value investing texts. However, he chose to incorporate things he had picked up previously with his new, value oriented approach. I think that his willingness to create his own systems and methods for investing highlight his ability as an investor. He wasn’t just a mindless drone that would follow whatever he read in books.
Take this rule about new lows, it shows that Burry was able to think critically enough to come up with his own investment rules:
As you know, I have a simple philosophy: sell on new lows.
There are two reasons for this:
1) Many people do this. It’s a self-fulfilling prophecy. I try to do it quicker.
2) If I know something is a fundamental value and it breaks to new lows, the selling is irrational by definition and I don’t want to be in the way of irrational selling. Better to wait for the buyers to show where they are willing to step up and give support.
I suffered for several years trying to be stubborn in the face of irrational selling and all it got me was a lot of 50% haircuts on stocks that had already been too cheap. One of the biggest lessons I’ve learned was that PE 8 stocks can become PE 4 stocks and stay that way for a long time. AT&T’s long-distance business is getting close to trading for 1X EBITDA, yet everyone looks at it like this big albatross around T’s neck. Maybe in the future I’ll get the long-distance biz for free. All we need is another $15 billion in lost market cap.
That said, I love your rhetorical questions. Why do you think AT&T is getting hit?
Mike
(Silicon Investor)
To me, that is an important aspect of learning investing. Most people will read a book about Warren Buffett and begin to think that there is only one way to really do investing. That kid of thinking really limits you. And Burry brings this up in the context of the tech bubble:
OK, here’s where I go and offend a lot of people. Religion? Style? What’s the difference? I’m sitting here fully expecting AMZN to go to 10. Don’t expect incredulity from me just because I haven’t seen it happen before. At some point, I did give up on my tech ban. Reason being that they are businesses like any other, and I couldn’t justify not valuing them. It’s fashionable for value investors to steer clear, certainly because of Buffett’s influence. But it is possible to invest intelligently there, IMO. I can’t just stick my head in the sand and say Microsoft didn’t make a lot of really intelligent investors very wealthy. Ratios bite. That’s gotta be lesson number 1 in tech value investing. I learned it with one stock – Creative Labs. Applying a little bit of Buffett to tech isn’t heresy or impossible, IMO…
Mike
(Silicon Investor)
Burry’s willingness to analyze tech companies is more evidence of his propensity to think independently. He makes a great point, totally ignoring tech on the basis of Buffett saying “tech is too hard” is probably a bit of an over generalization. If you look at some of his other posts, he gives some insights into how he evaluates tech stocks:
I just go for what has value. To me, ignoring tech doesn’t make sense. I’ve done well with Apple, Oracle, American Power this year. IMO, applying traditional value criteria to tech is deadly, because there is usually a reason it looks like a value, and it is too technical to understand.
So in tech I look for:
1) Big, Buffett-like established companies with tremendous
cash-generating ability that are out of favor despite a franchise on something
2) Small techs trading at about cash with no debt. They usually do well in my experience.
In tech, good management is rare and when it is present limits become merely a figment. But for an outsider to somehow judge this before the Street does – I don’t know that it is possible.
(Silicon Investor)
To Burry, you don’t need to ignore all of tech. Actually, when you look at established tech businesses, they are really some of the best. They tend to have clean balance sheets and are usually almost debt free, making the capital structure very straight forward. For a new investor, a mature tech company is probably easier to analyze than a bank.
Burry breaks tech into two piles. The Buffett businesses are ones that have wide moats and earn a lot — think Microsoft or Ebay (which Scion Capital has owned). The Graham businesses are likely small cap / micro cap stocks that the market has forgotten about, you will often see some of these tech companies on the net-net list (Adaptech comes to mind).
Here is how he described Apple:
I like AAPL because it IMO is now a bona fide value stock on an enterprise value/ratio basis, and is generating tons of cash. I see loads of opportunity, an extremely strong balance sheet, and little downside. And I see a huge contrarian play because a generation of security analysts have been trained to think that whatever is wrong with this world, AAPL is a part of it.
What the price will do in the next 12 months, I don’t know. Whether day traders will ever mature, I don’t know. Whether value will even become more important over the next year, I don’t know. I just see an absolute value in AAPL at recent prices.
I do feel the greatest margin of safety was back at 34 when no one ever thought it would move, but that there remains a margin of safety for longer-term holders.
(Silicon Investor)
If you were willing to overcome your biases against tech stocks, you would have seen a no-brainer value investment with Apple. Around the time of Burry’s post, Apple had about $4.5B in cash and marketable securities, with only $300M in debt. If you had taken Apple’s market cap, added the debt, and backed out cash, you would have ended up with the operating business being valued at only 10% of sales. That is absurdly low. The thing is, I am sure many investors missed this because they chose to ignore all tech stocks.
In The Big Short, by Michael Lewis, Burry argues in favor of creating your own investment style:
Burry did not think investing could be reduced to a formula or learned from any one role model. The more he studied Buffett, the less he thought Buffett could be copied; indeed, the lesson of Buffett was: To succeed in a spectacular fashion you had to be spectacularly unusual. “If you are going to be a great investor, you have to fit the style to who you are,” Burry said. “At one point I recognized that Warren Buffett, though he had every advantage in learning from Ben Graham, did not copy Ben Graham, but rather set out on his own path, and ran money his way, by his rules… I Also immediately internalized the idea that no such school could teach someone how to be a great investor. If it were true, it’d be the most popular school in the world, with an impossibly high tuition. So it must not be true.”
The Big Short (Michael Lewis)
Basically, Burry did not reject Buffett, but he understood the limitations that came with Buffett’s teachings. He didn’t have Buffett’s resources or talent for influencing management teams. As a smaller investor, he realized that he had to create his own approach so that he could invest effectively.
3. What everybody else was doing was insane
“The late nineties almost forced me to identify myself as a value investor, because I thought what everybody else was doing was insane.”
Michael Burry (The Big Short)
I am a huge believer in having investors study historical financial crises and panics since markets naturally have a tendency to become bubbles. Investors who have never really experienced a bubble will usually relax their investment standards after having a string of homeruns. This almost always leads to disaster, which we saw it in the most recent crisis. Many fund managers lamented that they had strayed a little too far from their core competencies and their investments suffered.
I was really curious about why Burry decided to do the credit default swap trade while so many other investors had missed it. Part of the reason Burry was able to see the mortgage bubble may have been a result of having honed his investment abilities during the dot com bubble. If you look through his posts, he knew the markets were being irrational:
A very, very close friend of mine whom I work with and talk with 6 hours a day has in the last 3 weeks quintupled his net worth on a single stock. Today he crossed $500,000. He’s not an insider at a company or anything. He’s just a resident phsyician who’s buying what everyone else is buying, and he’s telling me the same thing: fundamentals don’t matter anymore; who wants to talk about fundamentals?
Paul, if doctors make lousy investors, what does it tell you when doctors are making excellent investors – in droves?
Mike
(Silicon Investor)
Here is an interest exchange that Burry had with Reginald Middleton, who at the time was selling financial models that projected Microsoft to be worth north of $500 per share:
Reginald,
You appear to be arguing that junk bonds and technology equity investments have more value because they have been yielding higher returns over the last 7-10 years, thus counterbalancing the risk to a sufficient degree to call these value plays. This is the logic of a growth investor. What if you buy junk bonds just before the next crisis? Or if you buy A junk bond and the company deteriorates or is cannibalized by the people that sold it to you? You’ll be sitting on a big fat capital loss. This risk is high, hence the name.
How about the Nifty Fifty and the 72-74 crash? Good companies that didn’t see a return to their previous levels for over 10 years. In the inflationary environment of the mid 70’s to early 80’s this was devastating for holders of these growth stocks (which had been deemed “safe” due to their previous returns during the 60’s bull and size/history).
This is why we use AAA corporate bonds and gov’t securities as benchmarks for a safe return. Hold until maturity and you are guaranteed (as best as can be expected — if you don’t trust the gov’t, check out AAA bonds oneself) at least a modicrum of insurance against inflation. I am not arguing that your model doesn’t do this implicitly.
In sum, if you buy at the top, where’s the value? This is what Margin of Safety is meant to address, and why many people distinguish value investing from growth investing.
Mike
(Silicon Investor)
Finally, there is this:
Jim, I overheard two conversations today. Both were about investing – one involved the med center librarian, the other a janitor. Moreover, the friend I describe with the half-mill is not the first overnight success story. As I might’ve mentioned before, my two best friends and my younger brother’s two best friends all became multimillionaires this year. But you know, even though I’m here in Silly Valley, I’m on the fringe – that same guy who made half a mill went on a date with an HP IS employee who said it’d take 2 mill to buy her house. When informed of his goal of 3-5 million in a few years, she scoffed and said “That should last 2-3 years.” Then she asked what doctors are making in the Valley. He said “$100 to $120k.” She actually sniffed.
Jim, I’m reversing my position on your QQQ short, although I’m not yet doing it myself. Never, ever have I heard stock discussion permeate the medical center like this. This is new to me in the last few weeks.
Mike
(Silicon Investor)
Unlike most people at the time, Burry realized that he was living in a bubble. It didn’t make sense. Hearing about janitors, librarians, and co-workers, making such outsized returns with little actual investment analysis must have been jarring. The thing is, Burry not only realized that there was a tech bubble, but he sought to profit from it.
Shorting is a somewhat debated topic among value investors. They often complain that shorting saddles investors with potentially unlimited losses and runs counter to the fact that stock markets generally rise. I thought examining Burry’s perspectives on short selling would be insightful:
I’ve brought this up before, but since there’s a new group hanging around,
Does anyone have any rules for shorting based on a value basis?
I’m currently short KO on a value basis and am looking to short G next. (My AXP and WFC shorts are not value-based).
Mike
http://siliconinvestor.advfn.com/readmsg.aspx?msgid=1213782
Even though his shorts were more based in TA, Burry gradually refined his approach to incorporate more fundamental analysis:
I mentioned that I pick stocks to short based on valuation, not ratios (I ask you to find the correct free cash flow — I bet most people don’t kow they’re working with negative net working capital, either).
But I ENTER based on technical analysis. KO could go up or down. The odds are down, technically, but that’s what buy stops are for. This isn’t a long term short by any means. Research on shorts show that profitable shorts make money with small gains, not by waiting for businesses to bankrupt. The small gains are usually there for the picking. Another indicator — if it’s mentioned in Barron’s as a buy three different times — set me onto Wells Fargo.
What’s there to understand about Coke? The business is a KISS model. This gets to my value/short strategy. When people start claiming a business deserves a special valuation above all reasonable
fundamental analysis (because of the “franchise”, because there’s so little institutional ownership for a big cap growth stock, because Buffett’s in it, because global expansion will provide endless opportunity, because ROE is so damned high, because it’s nearly a monopoly, because Buffett’s in it…), that’s a short, IMO.
I just read a bunch of Graham, and he doesn’t deal with shorts (I assume it would be “speculation”), but EMT isn’t all that its panned to be either, IMO.
Just trying to think independently,
Mike
(Silicon Investor)
With further refinement, Burry started to create screens to pick up possible shorts. Here is one:
A study came out on shorting late last year. It basically said ignore the momentum plays because they move irrationally and fast. Look for companies with immense debt, crummy balance sheets and declining sales. And then hold for a while. This is just so against my nature, if not all human nature.
I screened for negative sales growth plus LT Debt>>equity, and PSR>20. The screen works, in a sense — you get all kinds of companies trading for less than a buck, and a lot of low cap oil&gas explorers. Nothing marginable, so hence they are not shortable. If you leave out the balance sheet problems you get a bunch of development stage cos, esp. biotech. But it seems to be on the right track. I’ll keep trying.
As long as you put tight stops on the shorts, there’s no unlimited risk. Problem is, how much do you believe the stock will go down? I’m only aiming for 10% in a bull market (which usually happens either quickly or not at all given my technical entry) so I need tight stops. Got stopped out of all mine today except IBM. This is why I’m looking for a value-based alternative.
Good investing,
Mike
(Silicon Investor)
Even though he was trying, he could not totally come up with a pure value approach to shorting. In this post, Burry describes how his process is still driven by TA, but that he is closer to figuring out a value based strategy:
Re: stops and shorting
Effectively, you need to use technical analysis. My shorts, though fewer in number by far, have been more successful than my longs — what that says about me I don’t know. Alternatively, you could just use percentages, but to me that’s a shot in the dark. Or if you know the company intimately, you could just waitbecause you know it’s going down.
Using TA, you can find, say, when a company is bumping up agains some significant overhead resistance, hitting a trend channel boundary, or hitting a Fibonacci number on a retracement during a downtrend. There are lots of other examples. Then, you just set a mental stop to get out if the scenario doesn’t play out technically. My futures experience led me to study TA intensely. I can’t help but use it for position entry in stocks.
To answer someone’s question, shorts do not free up cash. They are always borrowed (you are shorting stock that your brokerage borrowed for you from another investors margin account), and hence in your margin account. But it’s not like you can keep 100% shorts and then still have 100% cash to play with.
BUT this is TA. Stops are not a part of value investing as I understand it. Hence my search for a value-based strategy.
Shorts take a lot of maintenance as I practice it.
I may have found something, and am currently researching it.
Mike
(Silicon Investor)
This is where Burry’s past experience with trading futures was probably helpful. By using frequent stops, he limited the possibility of unlimited losses from a short position. Since he is incorporating shorts into his portfolio, Burry allowed himself to actually profit from the fallout of the bubble popping. Most other investors, who chose not to short, were left putting more and more of their portfolio into cash. Cash is not necessarily bad, while it does not earn returns or compound, in the short term it doesn’t decline.
One of the books that Burry recommends for learning short selling is The Art of Short Selling by Kathryn F. Staley. Here is what he had to say:
For the last week I’ve been carrying “The Art of Short Selling” around with me just about everywhere. Every time I get a break, I just open to a chapter. Doesn’t matter if I’ve already read it. I just read it again.
If there’s one thing that keeps hitting me in the head about that book and its cases is that there’s a lot of time to short and still come out ahead. The problem with net stocks is that they appear as if they require constant capital infusions, which makes them good shorts. But they’re getting these infusions at will. That makes now now a good time. When the capital spicket is turned off, the stocks will react downward, but won’t fully account for how bad the news is then. They’ll be terminally wounded but the price won’t reflect it. That’s when IMO you’ll be able to grab a lot of the net stocks on their way to zero. But before that, a lot of smaller companies will pitch themselves to larger companies. So the wild card is that they get taken over by a bigger, stupider, more capital-rich, company, a la Yahoo of GeoCities, which stands out as the single most characteristic action of this era. The AofSS describes this risk as the thing that keeps ss’s sweaty-palmed and awake at night. I think for good reason.
For my next, more certain short, I’m taking a long, measured look at Pre-Paid Legal (PPL). I posted why over on that thread. I think I finally understand that one.
Mike
(Silicon Investor)
Increasingly, we see Burry progressing towards shorting on the basis of fundamental analysis:
Shorting stocks where I can see the bad news confirmed in the numbers. Amazon.com (short at 82 5/8 again today) is pursuing some creative financing to get the cash to keep going. Selling euro-dominated bonds follows an Australian issue follows equity-linked debt follows who knows what.
Exodus (short at 129) is in a capital-intensive business with high start-up costs and business inputs that have short half-lives. The barriers to entry are minimal in the long run. Exodus’ major shareholders have sold big-time. The company should be raising its needed additional capital by selling inflated shares but instead is borrowing $1billion plus at 10%+ rates. Intel is one of the many targeting this same market.
Pre-Paid Legal (short at 24 3/4) I’ve gone through before (I shorted it from $37ish down to 24ish last year). Cash flow continues to lag far behind reported net income, membership retention stinks, and the CEO is engaging in borderline stock promotion while he steadily sells. Many in the investor community misunderstand this stock.
(Silicon Investor)
You can see the improvement and progression in his process. You will note that the analysis is more sophisticated here. It is much more value based, akin to an approach that you might see touted by a guy like Jim Chanos or other noted short sellers. With Amazon, Burry found the overall business model to be a bit suspect and disliked the complex financing. Exodus was a weak business that required large amounts of capital investments and financing that could only be raised at 10%+. Conversely, he was able to see larger businesses like Intel pose as competitive threats with the benefit of a cheaper cost of capital. Pre-Paid Legal, which astoundingly still exists today, is often a favorite among shorts. The mis-match between cash flow and net income is found in a lot of fraud businesses and is one of the indicators for trouble that you will find in forensic accounting books.
I talked about Burry’s willingness to modify Graham’s teachings to fit his own style and the time period. I think that shorting is simply an extension of that. In one instance, after being criticized by another investor, Burry outlines his philosophy on shorts:
Craig,
I wouldn’t go far as to say shorts are not part of a value investing strategy. To each his own, but one might argue that with bonds providing a weak counterweight to stocks over the last few decades, hedging with shorts might be something Graham would have considered by now had he been alive. He definitely was into market timing, and it wouldn’t surprise me to learn that he felt that shorts had a place in a rich market as a hedge against a majority long equity position. And re: Paul’s remark about hedging and shorts never coming up, I submit that Graham’s Bonds/Equity 25/50/25 theory was meant to be the equivalent of a mild hedge strategy. As for me, I’ve come out ahead on my shorts over the years, but I much favor longs, and in a fairly priced or evem overpriced market will still overwhelming favor longs…
Good investing and keep contributing,
Mike
(Silicon Investor)
Later, he cites the Rediscovered Benjamin Graham book’s material in order to argue that going long value stocks may not be enough if we are faced with a downturn:
“I’d like to think that if I own real absolute value stocks it won’t matter if the big indexes drop 50%. But that might be wishful thinking. ”

Jim, in that Rediscovered book, Graham makes it quite clear that value stocks will be punished every bit as much and probably more in a market downturn, according to his research. He of course advocates raising cash or adjusting to bonds if one thinks the market is too high. In another area, though, he talks of the tremendous values that can be found even in a high-priced market. I find this book fascinating — lots of stuff I hadn’t read before.
Mike
(Silicon Investor)
Eventually, Burry was able to incorporate short selling as just another weapon in his arsenal for value investing. Later, you can really see how improved his level of analysis has become. Take this post on WorldCom:
To answer whether this is a good business (and not just apparently cheap based on traditional superficial measures) I coincidentally just did a new return on capital calc on WCOM today, based on its latest results. Largely, I go by Stern and Stewart’s version when doing this. In terms of earning cost of capital, Worldcom is doing a poor job.
In fact, it is not earning its cost of capital. After accounting for past pooling acquisitions, and breaking down Worldcom’s cash flows, I figure the company is going to earn, optimistically, $8 billion in cash earnings on invested cash thus far somewhat above $90 billion. Even looking ahead and taking analysts estimates into consideration, I’m seeing at best a 10% return here and hence WCOM is not earning whatever its cost of capital may be – I’m estimating at least 12%.
Right now, it trades above its capital even though it is not earning the cost of its capital. Not good. This may change as WCOM finds a way to leverage its investment into further profits down the road. The latest quarterly report provides a hint of this. But it has said it will have massive capital expenditures in the future – and current cash levels imply additional borrowings to do it. All this will dilute returns further.
I think with T and WCOM, we’d have to find a way to analyze the current levels of investment and somehow come to a conclusion that future earnings will grow quite significantly off this base alone. One wonders what degree of empire building is going on – what is motivating management? Right now, T seems to have the greatest potential because of its cable assets, but it is potential. Management has to execute. Plans to spin off or merge with BT tell me that management is responding to the wrong inputs right now. Ebbers’ Sprint plan told me he is responding to the wrong inputs as well…
Following up on my examination of Worldcom, I concluded that Worldcom would have to start showing it didn’t need more acquisitions. Its acquisitions to date seem to have been borne of empire-building rather than shareholder reward. And the market is knocking it down drastically on news of its latest acquisition. Certainly it appears that the “story” phase for the stock is over, and the proving time has begun. But Worldcom is still trying to finish the story. I’m still staying away.
Good investing,
Mike
Part I (Silicon Investor)
Part II (Silicon Investor)
As many of you already know, WorldCom had engaged in massive accounting fraud. Some of this was covered up through their clever use of accounting with acquisitions. Each deal boosted their reported earnings whereas it was obvious to Burry that they weren’t even out earning their cost of capital. Being able to pick up on small details like this must have been helpful later on when he had to analyze complex subprime-mortgage backed securities.
4. The Big Short
Burry was relentless about seeking out value. That meant buying undervalued tech stocks and shorting the ones that had shoddy fundamentals and were irrationally bid up. To me, when we read about Michael Burry netting huge from credit default swaps against mortgages, we are just seeing an extension of his process.
Value purists may disagree with using credit default swaps because they are derivatives, but Burry’s wasn’t a purist. He isn’t the first value investor to get attracted by insurance. Warren Buffett has had a long history of involvement in the reinsurance business. For Buffett, insurance is all about taking premiums for well priced policies and investing them in the market to compound returns. For Burry, it was more of the opposite. He was being presented with premiums that were so low, relative to the huge payoff, that the CDSs were actually undervalued and worth investing in. His CDS positions may have costed 5% annually but had the potential to deliver 100:1 payouts.
What is funny is that in his SI posts, you could see that Burry was already suspicious about the possibility of a housing bubble back in 1999 with a post about Washington Mutual:
…with equity/assets of under 5%, WM is not in the strongest shape should its fundamentals deteriorate, i.e. real estate deflate. Out here in Silicon Valley, everyday life feels like a bubble. People can hardly comprehend when I tell them about 90-92 and the foreclosures – not when 2br/1b’s are going for 5-600k. I just can’t help but think that it will get even uglier before it gets better.
Mike
(Silicon Investor)
Burry constantly frets about the potential downside and isn’t deluded into thinking that markets will remain stable. In his posts he brings up cases where investors are afflicted by delusional euphoria. The Nifty-Fifty days, the early 90’s real estate foreclosures, investor behavior during the tech bubble, the ever appreciating home prices in California; he comes off as almost always vigilant against the the possibility of another disastrous bubble around the corner.
In the Michael Lewis article, Betting on the Blind Side, Lewis describes how Burry learned about mortgage bonds:
In early 2004 a 32-year-old stock-market investor and hedge-fund manager, Michael Burry, immersed himself for the first time in the bond market. He learned all he could about how money got borrowed and lent in America. He didn’t talk to anyone about what became his new obsession; he just sat alone in his office, in San Jose, California, and read books and articles and financial filings. He wanted to know, especially, how subprime-mortgage bonds worked.
Betting on the Blind Side (Vanity Fair)
Going back to Burry’s past, we know he had a penchant for self-teaching. The way he learned about subprime-mortgage bonds was probably similar to how he learned about investing. Simply by self teaching. My guess is that most investors did not bother wading through subprime mortgage bond prospectuses. At most, they may have double checked the rating on the bond by calling up the people at Moody’s or S&P. For Burry though, we know that when he learned something, he sought complete understanding:
The problem is, I don’t believe anything unless I understand it inside out. And even once I understand something, it is not uncommon that I disagree with accepted view (even if it’s a Nobel laureate). So I struggle pretty mightily with my own perceptions and definitions every once in a while. That’s where I am now.
Mike
(Silicon Investor)
That drive to figure out the ins and outs of every subject must have contributed to the fact that he was willing to sit down and understand all the granular details of a subprime mortgage bond. I doubt listening to a ratings agency or the common market sentiment was enough. He had to personally understand everything. And that singular focus led him to see that subprime mortgage bonds were really a sham:
But as early as 2004, if you looked at the numbers, you could clearly see the decline in lending standards. In Burry’s view, standards had not just fallen but hit bottom. The bottom even had a name: the interest-only negative-amortizing adjustable-rate subprime mortgage. You, the homebuyer, actually were given the option of paying nothing at all, and rolling whatever interest you owed the bank into a higher principal balance. It wasn’t hard to see what sort of person might like to have such a loan: one with no income. What Burry couldn’t understand was why a person who lent money would want to extend such a loan. “What you want to watch are the lenders, not the borrowers,” he said. “The borrowers will always be willing to take a great deal for themselves. It’s up to the lenders to show restraint, and when they lose it, watch out.” By 2003 he knew that the borrowers had already lost it. By early 2005 he saw that lenders had, too…
In his quarterly letters he coined a phrase to describe what he thought was happening: “the extension of credit by instrument.” That is, a lot of people couldn’t actually afford to pay their mortgages the old-fashioned way, and so the lenders were dreaming up new financial instruments to justify handing them new money. “It was a clear sign that lenders had lost it, constantly degrading their own standards to grow loan volumes,” Burry said. He could see why they were doing this: they didn’t keep the loans but sold them to Goldman Sachs and Morgan Stanley and Wells Fargo and the rest, which packaged them into bonds and sold them off. The end buyers of subprime-mortgage bonds, he assumed, were just “dumb money.” He’d study up on them, too, but later.
Betting on the Blind Side (Vanity Fair)
My guess is that most of Wall Street did not bother to wade through the hundreds of pages that comprised a subprime MBS. Unlike Burry, who sat in an office and learned these bond deals by himself, most of Wall Street likely deferred their judgement to the ratings agencies or sell side contacts. Ultimately, those groups lacked any substantial knowledge about these securities, their models were flawed which made their opinions flawed. So when investor groups came to them to get their opinions, they were almost always given the wrong answer.
Going through all of Burry’s posts, you will see that he was constantly analyzing stocks. To the point where he was at least posting a few ideas every week, in addition to his day job. To me, that is the definition of deliberate practice for an investor. You really have to get into the habit of frequently analyzing and valuing companies. In one post, Burry mentions that he has built a watch list of over 80 companies that he would be ready to pounce on if they ever hit his target price. That level of work, with a tendency to think independently, should help improve anyone’s investing.
This quote by Michael Burry in The Big Short says it best:
I have always believed that a single talented analyst, working very hard, can cover an amazing amount of investment landscape, and this belief remains unchallenged in my mind.