How To Beat Hedge Funds and Warren Buffett

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I took this photo near Koh Phi Phi, Thailand. Love that place.

I will explain how I beat most of the hedge funds and Warren Buffett.

As explained in About Me, I work in technology, relied on others for investment advice and after losing money, I started to make my own investment decisions in 2008.

I spent a great deal of time on investing and stocks in 2008 and 2009.  Since then, I have spent less time as I refocused back on my technology work.  Overall, here are my average annual returns:

2008-2013:

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2009-2013:

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(Yes, my above returns accounted for deposits and withdrawals by using various formulae such as XIRR and Money-Weighted Rate of Return. BarclayHedge Index and HedgeFund Intelligence track the performance of hedge funds. Return for S&P 500 should be approximately 2% more than what is shown, to account for dividends. If you are a fund seeder, the above numbers can be verified.)

In 2008, the markets and my portfolio were going down. After my research, I felt that there was a possibility of another bear market. The U.S. housing bubble was all the rage for several years. If it stopped raging, this might affect the economy and then stocks. Interest rates had gone up.  Yield curve had inverted a few months earlier. Leading economic indicators did not look good. If you had to put a probability on it, there was a lower probability of continued upside than for it to peter out. I thought that a bear market could last two to three years as in the past. So, I went to mostly cash in March 2008, holding on to one stock and a very small amount of two mutual funds.

To my, and everyone’s surprise, the stock market crashed. Since I went to mainly cash, I did better than most hedge funds and Warren Buffett in 2008. I believed that there was going to a bear market, but I had no idea that it would be as severe and quick. I attribute the severity and quickness to luck.

Towards the end of 2008 and beginning of 2009, I could not believe how cheap stocks had become. I told close family members repeatedly that we had an opportunity of a lifetime with stocks. I was as excited as a teenager on his first date. I was reluctant to tell people other than close family and friends because I was still not very confident in my investing skills. After all, I was still a novice compared to thousands of others.

One of the people I told was Harry. Harry is a good friend of mine who has worked on the stock market for over two decades. I explained that the gains to be made when coming off of the bottom were going to be significantly more than the gains to be made later in the bull market. He didn’t share my excitement.

I provided an example. Let’s suppose the market bottoms at 100 points. If it goes up by 10 points to 110, it has gained 10%. But when it is later in the bull market and it goes up 10 points from 200 to 210, it has gained 5%. This is lost on most people.

To graphically show this, I showed Harry a comparison between a linear and logarithmic chart of the S&P 500. Harry could not understand the logarithmic chart. I read business sites and watched business TV incessantly during this time. Nobody was saying that this was an opportunity of a lifetime. I was beginning to feel that if I had to take advantage of this crash, I was going to be on my own. I knew that I wasn’t the only person who took advantage of this opportunity, but I was not aware of them at the time.

I tried to explain to people that one hour of work spent on investing in 2009 would be worth spending ten hours on investing after the market has recovered. It was critical for investors to focus on the stock market because this was an opportunity of a lifetime!  However, nobody shared the same sense of urgency.

Nevertheless, I spent most of my time towards the end of 2008 and every spare hour at the beginning of 2009 on the stock market, with my eyes peeled on CNBC, BNN, MarketWatch, SeekingAlpha and numerous other news sources. I even subscribed to and attended monthly VectorVest meetings. I knew that getting in one week after the bottom could mean losing more return than one can make in a year during regular times. I was learning everything I could about the stock market.

In the previous bear market, the S&P 500 dropped 49% in 30 months from March 24th, 2000 to October 9th, 2002. The S&P 500 dropped 56.8% in 17 months from October 9th, 2007 to March 9th, 2009. Few stock markets in the world were spared. The world had become so integrated that the U.S. was pulling every one down in almost perfect tandem.

At beginning of February 2009, I wondered if we had hit the bottom. I dipped my toe in by taking small positions in Alpha Natural Resources and TransOcean. Nope, turns out it was a dead-cat bounce. I sold shortly afterwards.

I learned that small caps rise faster coming off the bottom. I used VectorVest’s search tool to find the most undervalued small caps. The search gave me a list of 100-200 stocks. From this list, I looked at the chart for each stock, to find the ones with the smoothest chart before the start of the 2008 crash.

I wanted to find stocks that were pulled down by the general market. If any of them started declining before the market crash, it meant that they had problems specific to the company. From my chart and fundamentals analysis, I shortened the list to approximately 30 stocks. Since I was a novice and I had never picked stocks before, I questioned my ability. I sought out Harry, who works in Finance. I wanted him to vet my list and shorten it down further, as I eventually wanted 10 stocks.

However, Harry was going on vacation and wouldn’t be available to review my list. This was in March 2009 and I was anxious for him to return. I knew time was money and I wanted to have my 10 stocks picked so I could jump in as soon as I felt the market had bottomed. It surprised me that Harry was so lackadaisical about the market. Didn’t he know that getting in as close to the bottom was crucial? Didn’t he realize that if he got in one month, or even one week, closer to the bottom, he could potentially make a couple of hundred of thousands of dollars more and therefore he should postpone his vacation? No, he did not have the same sense of urgency.  In fact, he stated that he usually likes to see a trend before getting in.

When stocks are so cheap, most people panic but it’s an opportunity of a lifetime. Show fear when others show greed and greed when others show fear. I would find out later that most people invest like my friend Harry. They look at the rear view mirror instead of through the front windshield.

I looked at the charts of my stocks and I was in shock at the degree with which their prices had plummeted. Many of them were down 95+% and from what I could tell, they were down mainly because of the market crash or because the recession had impacted their revenue and profit.

If they recovered to their previous levels, I stood to make 1,000% gains or 10 times my money. Las Vegas Sands was a clear example of one of these stocks. It traded at a peak of approximately $138 in 2007 and plummeted down to approximately $2 in March, 2009. That is a 98.5% drop. It was trading at a fraction of its book value. During any recession, one industry that gets hit hard, is consumer discretionary. This makes sense as people spend less on luxuries, such as trips to Las Vegas.

What exacerbated the decline of Las Vegas Sands was Obama. Financial firms, that were bailed out, were still sending their employees to conventions in Las Vegas. Obama censured them, rightfully so for doing this. The President did not want companies to send people to Las Vegas. This caused investors to dump Las Vegas stocks, as if it was the end for Las Vegas.

Users on Yahoo Finance commented on how ridiculously cheap that LVS was. One user said that if anyone loaded up on LVS, they would eventually be driving a Ferrari. I agreed based on logic and intuition. However, I still had doubts. Could it really be this easy? Why would other investors sell this stock when it is so cheap? Couldn’t they see that the recession and Obama’s disapproval were temporary issues? Couldn’t they see that humans have gambled for thousands of years and will gamble for thousands more? Couldn’t they see that Las Vegas would rebound? In later years, I would learn that the market can stay irrational longer than you can stay rational (or solvent).

It’s common knowledge that stocks peak before the beginning of the recession and bottom before the end of the recession. Therefore, it’s important to know that there will be negative economic news persisting for months after stocks have bottomed.

During the week of March 2-6, 2009, I was watching CNBC’s Larry Kudlow. Doug Kass was on the show and predicted we would hit the bottom of the market in the next few days. Was he going to be right? The suspense for me was more intense than any movie or rollercoaster.

It was readily apparent that the financials were leading the charge downward, especially Citigroup and Bank of America. The market was not going to bottom until these two bottomed. News from any other company was irrelevant.

Up until March 9th, 2009, I was reading everything I can get my hands on in regards to the banks. On the morning of March 10th, before the market opened, I was scouring the news as usual, looking for any good news or indication of a turnaround. There it was. Vikram Pandit, CEO of Citigroup, sent an internal memo the night before. The line that caught everyone’s attention was: “…we are profitable through the first two months of 2009…” The market spiked 6.3% that day. Had we reached our bottom? Was it up from here? It was possible but I still wasn’t sure.

Now, I was very anxious to meet up with Harry to vet my list but he was still on vacation. So, I waited…and waited…and waited. While I waited,  the market rallied. I should have gone ahead and jumped in but I wanted somebody with experience in finance to give me a thumbs-up on my list. This turned out to be a mistake.

Finally, Harry returned and vetted my list. He scratched off some stocks and okayed the rest. In later years, I realized that one of the stocks scratched from the list, Dollar Thrifty, rose 4,416% from April 17th, 2009 until December 24th, 2011 (I recorded this data in 2011 but since then, Dollar Thrifty has been acquired and prices after December 2011 are no longer available.). Here are some of my other picks:

On April 15th, 2009, I bought Boise and CrossTex Energy
On April 16th, I bought MacQuarie Infrastructure
On April 17th, 2009, I bought Harry Winston Diamond, Las Vegas Sands, Sonic Automotive, OceanFreight, Trico Marine and Mesa Airlines.

Eventually, 99.5% of my portfolio was in stocks.

The next few weeks were nothing short of a wild, exuberating ride. I’ve never seen stocks go up so fast. I’ve never seen my wealth increase so fast. However, if I had gone into the market a month earlier, my portfolio would’ve increased by an additional 100+%. The beta was unbelievable.

The stocks I owned were incredibly cheap. I should have held on to them for dear life or at least until the market valued them fairly. In subsequent months and years, my inexperience would cost me. Like most people, I was scared of volatility and of losing money. Consequently, I got whipsawed out of most of my stocks, buying back in later or buying different stocks. (One of these examples is Las Vegas Sands). Or, I lost patience with a stock after a few months if it wasn’t going up when my other stocks were and sold it. This happened with MacQaurie Infrastructure.

In later years, I would come to regret these decisions immensely. If I kept all of the stocks I bought in April, 2009, my portfolio would’ve gone up by approximately 1,200% over the next five years. If I bought them in March, 2009, my portfolio would’ve gone up by approximately 2,400% over the next five years. That’s right. 2,400% for the portfolio, not for any one stock. But I screwed up. I did not keep the same stocks that I bought in April, 2009. Some of my stocks were dogs and eventually went to zero. Nevertheless, because I kept close to 100% of my portfolio invested in stocks, my portfolio doubled in 2009.

A relative had an interesting comment for me in 2009.  She said that I was “so aggressive”.  She implied that I was a big risk taker.  On the surface and to most novice investors, this would seem true.  In reality, I was not.  Buying stocks when they are cheap is taking far less risk than buying them when they are expensive.  Most people tend to think that buying a bank stock at $80 in 2007 was safe but they thought it was risky to buy it at $40 in 2008.  Most retail, uninformed investors tend to have risk management reversed and consequently are the big risk takers.

2011 was very volatile, due to the debt crises in Europe and U.S. This caused a lot of distraction while I was trying to focus back on my regular, technology work, so I got out of stocks and missed the upswing in the latter part of 2011 and 2012.

2013 was good only because the broad market was good.

Because of my experience, I’ve worked as an Investment Advisor which opened my eyes to the investment industry. I learn new things about investing every year and I will share them with you in this blog.

I’ve learned that Investing Can Be More Important Than Your Salary, Why Most Funds UnderperformTruth About Investment Advisors, Top 4 Reasons to Buy Stocks, why people should Allocate 100% of Portfolio to Stocks and Secret to Warren Buffett’s success.

Get the Truth on Investing!