Bill Ackman is one of the handful of hedge fund managers who enjoys (if that’s the right word) widespread name recognition even among those who are only mildly interested in investing.
That’s partly because he’s very rich, but it’s mostly because he has a habit of making big public calls and also being quite vocal about things like Russia’s war on Ukraine, coronavirus, and other headline news topics.
Ackman is in the papers again today, this time for his investments. He’s just lost roughly $400m having sold his shares in streaming service Netflix, according to the Financial Times.
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A mere three months ago, Ackman built a stake worth $1.1bn via his Pershing Square investment vehicle. Those purchases came in the wake of a previous big sell-off in Netflix shares.
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At the time, Ackman wrote that Netflix was attractive because “many of our best investments have emerged when other investors, whose time horizons are short term, discard great companies at prices that look extraordinarily attractive when one has a long-term horizon.”
Now he’s dumped the lot, in the wake of Netflix’s latest dire results.
I will be the first to admit that it’s only human to find it at least mildly amusing when someone with Ackman’s reputation apparently screws up like this, particularly when they’ve made a big deal about short-term versus long-term investing. Even in the hedge fund world, it’s hard to describe three months as “long term” – at least, certainly not in the equity markets.
But it’s the wrong reaction. This was a textbook trade, despite the outcome, and it’s one that even the humble non-hedgie likes of you and I can learn a few things from.
If you ever try your hand at stockpicking or are tempted to do so, here are the three main lessons you can learn from Ackman’s Netflix trade.
1. You will get things wrong
The first thing you have to understand and internalise as an active investor is this: you will get things wrong. In fact, you will get lots of things wrong.
In Jack Schwager’s book Stock Market Wizards, he interviews another US hedge fund manager, Steve Cohen, who notes that “my best trader makes money only 63% of the time. Most traders make money only in the 50 to 55% range.” Stock Market Wizards was published in 2001, but I doubt the odds have improved since then.
Now, you’re not a day trader (I hope), but the point stands. Even people whose highly-paid job it is to do this stuff get things wrong all the time. So you need to cultivate sufficient humility to be able to accept that.
If you can’t, then get thee to a passive fund provider or at least an active fund manager who you trust to do the job for you, because you will struggle to make money as an active investor yourself.
2. What matters is what you do when you’re wrong
So if the key to making money as an active investor is not about getting all of your investments correct, then what is it about?
There’s an excellent short book out there by Lee Freeman Shor, called The Art of Execution. Freeman-Shor, a fund-of-funds manager, talks about his observations of giving top fund managers money to run, and what separated the winners from the losers.
It’s worth reading the book, but the short answer is that in situations like this one – where a stock you own suddenly plunged by 25% in a day – successful investors did one of two things. They either bought more – doubled down – or they sold out.
How did they decide? Because they knew why they’d bought the stock in the first place. They had their rationale in mind, so when they revisited the trade, they knew whether anything material had changed or not, and if it had, they could take that into account when deciding whether to sell or buy more.
Those who lost over the long run were the ones who failed to take action at all.
The point here is not that you should be doubling down on a profit warning. It’s that you need to do your homework before you buy in the first place. Do your research to work out why you’re buying before you do so.
Importantly, you should also write this down. I’ve written that in bold because I can guarantee that lots of the people reading this will ignore this suggestion, thinking that they can retain their reasons in their head. You can’t. When you’re facing eating a 25% loss, your mind will convince you otherwise. Write it down so the cold truth is staring back at you in black and white when it comes to rethink your investment.
In the case of Netflix, reports the FT, Ackman told investors that Pershing had “lost our confidence in our ability to predict the company’s future prospects with a sufficient degree of certainty.”
It looks as though Ackman’s initial case was based on Netflix being able to charge its existing subscribers more, with its content acting as a moat.
Now Netflix has talked about launching an advertising-supported streaming service. The company might be able to make that work, but the point is, by shifting to that model, it will become a very different company to the one that Ackman, three months ago, viewed as such a compelling “long-term” bet. Given that his initial thesis no longer held, and that he couldn’t have confidence in valuing the “new” future for Netflix, selling makes sense.
3. How to survive getting things wrong
The other key point is this: Ackman might be able to afford a loss of $400m, but most investors’ pockets just aren’t that deep. So the other key skill is to make sure that an individual loss does not wipe you out.
Successful poker players and day traders all understand one thing perhaps better than anything else: position sizing. By making sure that they don’t have too much money risked on any one trade (or hand) they can still make money overall because their winners outgain their losers.
For longer-term investors, the risk of being entirely wiped out or blowing up your account is typically lower. But the bigger picture lesson is certainly relevant. You need to make sure that your portfolio is diverse enough and that you aren’t staking too much on any one position. In short, you need to make sure that you aren’t betting your house on being right, because chances are, you’re not.
You need to be able to assess a position coolly and let it go, taking a loss if necessary, if your original thesis turns out to be wrong. That’s almost impossible to do if the scale of the loss you’d take would ruin you.
So that’s it: accept you’ll be wrong, plan ahead for it, and don’t bottle out of taking the painful decisions when those decisions need to be taken. That’s what Ackman has done. And whatever happens to Netflix now – even if it bounces and ends up going higher from here – the key point is that Ackman followed his process, acted with discipline, and made the right decisions. That’s something we should all aspire to as investors.
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