The world’s greatest investors: Jim Chanos

Jim Chanos was born in Milwaukee in 1957. After graduating from Yale in 1980, he worked as a research analyst at several banks and brokerage firms. However, negative publicity from an article about short sellers in The Wall Street Journal convinced him that being a bearish sell-side analyst was impossible (ironically nine out of the ten companies that were supposedly the victims of a short-selling cabal mentioned in the article ended up going bankrupt). In 1985, he set up hedge fund Kynikos Associates, which he still runs today.

What is his strategy?

Chanos analyses the balance sheets of companies in an attempt to spot signs of potential fraud. He will also examine companies who are making most of their money from “faddy” products (ie, Pokémon Cards). If his analysis suggests that the company is hugely overvalued he will short the company’s shares (ie, bet on its price falling). As a fundamentally driven investor he will close the position once he feels the risk/reward ratio ceases to be attractive or better opportunities come along. He currently has around 60 short positions.

Does this work?

Between 1985 and 2005, Kynikos’s main fund has returned around 2% a year. This may seem poor, but was an extraordinary result given that this was achieved by going short during a time when the S&P was producing a total return of 13% a year. If you had combined his fund with the same investment in an index fund, you would have produced a theoretically risk-free return of 15% a year.

What were his biggest successes?

Chanos’s most famous trade was shorting energy firm Enron. He became interested in the company when it started to go on an acquisition spree, but began investigating in depth when he read about changes to rules on valuing energy derivatives. Chanos began shorting the firm at $60 in November 2000. It went up to $80 before going bankrupt a year later.

What lessons are there for investors?

Careful analysis of balance sheets can identify hidden problems, even in companies that can appear to be profitable. However, the fact that stocks tend to go up over long periods means that it is difficult for short-sellers to make money from short-selling alone. Hence as well as his short-only fund, Chanos offers a market neutral fund that combines it with an equivalent number of long positions, as well as a third fund that combines short positions with leveraged long ones.