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4/21/2015

Risk and Portfolio Management Similarities between Joel Greenblatt and Stanley Druckenmiller | Base Hit Investing

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Things You Didnt Know About Buffetts Strategy

Risk and Portfolio


Management Similarities
between Joel Greenblatt
and Stanley Druckenmiller
By John Huber On April 21, 2015 Add Comment

Great Quotes

Were always trying to


wonder what can go wrong.
Were very focused on the
downside.
Bruce Berkowitz

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I have been busy over the past couple of weeks. My wife gave birth
to twins about two weeks ago, and now that I am back in the office, I
am catching up on some reading. While we were in the hospital for
about a week, I did have some time to do some reading, and I have
some comments on two annual reports of current holdings of mine
JP Morgan and Markelwhich I may turn into brief posts.
But briefly, I thought Id share two videos I recently watched of two

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great investorsone I talk a lot about, and one that Ive rarely
mentioned.
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Joel Greenblatt and Stanley Druckenmiller have put together two of


the all-time great track records.

Stanley Druckenmiller
Druckenmiller has arguably one of the four or five most impressive
track records of all time when you combine CAGR, assets managed,
and longevity. If there was an NCAA-style bracket for all-time great
investors, hed probably be a 2 seed, or possibly even snag the final 1
seed spothes that good. He compounded at around 30% annually
from 1981 until he retired from active money management in 2010.

Risk and Portfolio


Management Similarities
between Joel Greenblatt
and Stanley
Druckenmiller
Things Y ou Didnt Know
About Buffetts Strategy
Simple Concept of
Intrinsic Value Part 2
Portfolio Turnov erA

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He started with a few million and was managing tens of billions by

Vastly Misunderstood

the time he retired. He also famously co-managed the Quantum fund


with George Soros for a period of time (Druckenmiller actually
managed the fund and came up with most of the investment ideas
including the famous British Pound short. Soros was busy traveling
around Europe and mostly just provided Druckenmiller with general

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advice on position sizing and portfolio management).


Druckenmiller generally stays out of the limelight, and rarely gives
interviews. There is a chapter on him in New Market Wizards when
he was a young manager in 1992, but there isnt much in the public
domain relative to the size of his success. But recently he gave a talk
that was very interesting (transcript is here).
He runs a strategy that is very different from my investment
approach, but I still find him to be an interesting investor and his
talk had a few conceptual things that I think are important for any
investor who hopes to achieve significant outperformance over
time. In fact, I think there are a few simple, if not overgeneralized
reasons for his success.
These are mentioned in the lecture, but Ill highlight my takeaways
here:
He waits for the fat pitch. Ill paraphrase something he once
said: the best thing to do is sit around and do nothing, and then
when you see something, go a little bit crazy.
He is very willing to admit he is wrong (when the facts
change, he changes his mind).
He takes big positions when he finds high probability
ideas.

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I think these points were a big part of his investment philosophy,


and despite his strategy being one that I find difficult to replicate or
emulate, I think these concepts had more to do with his success than
his ability to analyze macro events, currency movements, or secular
trends.

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And in fact, those three points are usually exemplified in all the
great value investors. Druckenmiller says in the lecture that he
really sees no point in watering down your best ideas with marginal
ideas just for the sake of diversification. It only will lead to mediocre
long term results. He also says something I strongly agree with:

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there just arent that many great ideas. In order to get great results,

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you have to capitalize on great ideas. And you might only find 1 or 2
or 3 really great ideas in any given year.

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It takes patience and discipline to be willing to reject most


everything that comes across your plate, and then really capitalize
when you locate a high probability idea.

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So its not much different in terms of philosophy, just the way the
philosophy gets implemented: I tend to prefer undervalued high
quality businesses that I can easily understand, but Druckenmiller
and Soros found an edge by analyzing macroeconomics.

Joel Greenblatt-Different Strategy, Similar


Concept, Similar Success
Joel Greenblatton the other handran a much simpler (in my
opinion) strategy that is much more akin to my own investment
approach (thus the reason I mentioned him often and rarely have
talked about Druckenmiller).
Greenblatt made 50% annually for a 10 year stretch from 19851994 (something not even Druckenmiller and his mentor Soros
could match in their famous Quantum fund). Greenblatt and his
partner Rob Goldstein then returned outside money, but continued
running their own money using the same strategy for another ten
years, achieving great results.
Greenblatts strategy is nothing like Druckenmillers, but there are a
few philosophical similarities, namely that Greenblatt tended to put
most of his capital into the 5 to 8 best ideas he had at any one time.
He felt strongly that beyond this level, diversification didnt really
reduce any additional risk, but did water down results.

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There is a case study in Greenblatts first book that outlines an

Value Inv estors Club

average company that was trading for less than liquidation value (or

Value Walk

more likely, the value that the business could be sold to a private
buyer for). The twist was that the company had a very small retail
subsidiary that was growing and had enormous potential. The main
business was mundane, lowly profitable, and generally unattractive.

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April 2015 (1)

The small retail operation was just a small fraction of the overall
value, but if the concept worked, it could grow into a much larger

March 2015 (2)

piece of the pieperhaps equaling or exceeding the market value of

January 2015 (3)

February 2015 (1)

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the entire company.

December 2014 (3)


Nov ember 2014 (1)

Greenblatt recognized the growth potential of the growing retail

October 2014 (2)

subsidiary, and in fact underestimated the possibilities. But he knew


that since he could buy the whole company for less than what the

September 2014 (3)

main business could be sold to a private buyer for, he got what


amounted to a free call option on the retail business.

July 2014 (3)

August 2014 (3)


June 2014 (3)
May 2014 (3)

Things worked out as planned, and the retail business reported


strong growth and Greenblatt subsequently sold when the value and

April 2014 (3)

prospects of the retail subsidiary became more recognized.

February 2014 (4)

March 2014 (4)


January 2014 (6)

The case is interesting, but the thing I took away is that Greenblatt
said that his favorite ideas consist of finding an investment

December 2013 (5)

opportunity where there are very few ways to lose money and
multiple ways to win. In the case above: the main business could

October 2013 (6)

have been sold, assets could have been liquidated, or maybe the
operations could have turned around. And of course, the growing

August 2013 (6)

retail business was just gravy. There were multiple good things
that could happen and very few bad things. In fact, I dont recall

June 2013 (10)

exactly how the situation resolved itself, but I think the bad business
didnt really get better. I think assets ended up getting sold and the

April 2013 (21)

company more or less closed down the unprofitable line in order to


focus on the good business.

February 2013 (17 )

Nov ember 2013 (6)


September 2013 (6)
July 2013 (4)
May 2013 (11)
March 2013 (12)
January 2013 (5)
December 2012 (12)

T he point is that Greenblatts favorite ideas were the ones


where he felt there was very little chance of losing money

Nov ember 2012 (2)

not necessarily the highest potential returns.


In the video below, he emphasizes this point. (By the way, thanks to
Joe Koster who posted this videoI found it on his siteand Joe
also emphasized this quote, which is a good one):
My largest positions are not the ones I think Im going to make
the most money from. My largest positions are the ones I dont
think Im going to lose money in.
I think thats a very important thing to consider. Bill Ackman made
about 50% last year. His largest positionbecause of a catalyst that
he himself was very much a part ofwas a position that had a very,
very low probability of causing a permanent capital loss. As it turns
out, the investment worked out greatmaybe better than Ackman
expected, even though they were unsuccessful in achieving the
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outcome they originally set out to achieve (which was getting


Allergan sold to Valeant). Instead Allergan sold itself to a higher
bidder and Ackman probably smiled the whole way.
Some people dont care for AckmanIm not particularly fond of
big egos myself, but this was a brilliant investment by a very smart
manager. Very low chance of losing money. Upside uncertain, but
very low downside. Thus the reason Ackman had around a third of
his capital in it.
I think both Greenblatt and Druckenmiller, despite running
completely different strategies, both were successful in part because
they understood the importance of that concept.
Here is the Druckenmiller lecture: great read even for us much more
simple minded value investors.
Here is a video of Druckenmiller in a recent Bloomberg interview.
And here is the Greenblatt interview with Howard Marks that I
referenced above:

T A G G E D WI T H

Inv estm ent Philosophy Joel Greenblatt Portfolio

Managem ent Position Sizing Stanley Druckenm iller

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