T2 Partners Attributes Poor Performance to Contrarianism ~ market folly

Tuesday, April 5, 2011

T2 Partners Attributes Poor Performance to Contrarianism

Whitney Tilson and Glenn Tongue's hedge fund T2 Partners sent out a monthly update to investors and they reveal performance of -4.3% in March and -3.1% for the year. This trails the S&P 500, which is up 5.9% in 2011. More interesting than the performance figures, though, is the the notion of deviating from the herd and its subsequent effect on that performance.

T2 writes that, "a bigger reason for our underperformance, especially last month, is our investment strategy, which is rooted in deviating from the crowd with contrarian bets. It's the only way to outperform the market over the long term, but it also carries with it the risk - indeed, the certainty - that there will be periods during which one underperforms the market."

Obsession With Short-Term Performance

This is worth pointing out because Wall Street and investors are seemingly always fixated on short-term performance. In part, this is one of the reasons that Shumway Capital Partners returned outside investor capital (among many other reasons). In his letter, Chris Shumway noted that returning outsider money would allow him to focus on long-term positioning that he has been so successful with.

When investors place monthly expectations on a manager, rather than yearly ones, the manager is pressured to attain short-term performance and it compromises their core investment strategy.

Value Versus Global Macro Managers

To illustrate this point, we turn to a comparison between value-based investors and global macro traders. If a macro manager sees a mountain top (gains from a potential trade), he will go after it. However, if he encounters a valley (temporary loss of capital) on the way to the mountain top, he will pivot and trade around that position to eliminate near-term risk or even profit from the decline by temporarily shorting.

A value-based manager, on the other hand, will continue to hold their long position and ride out the valley (decline) in order to get to the mountain top (gain). Their deeply rooted stance makes them more prone to near-term underperformance.

T2's Letter

In the recent past, T2 Partners has blamed poor performance on their short positions. Yet despite covering their short of Netflix (NFLX), they puzzlingly held onto other valuation shorts like Opentable (OPEN) and Lululemon (LULU), but that's a whole 'nother conversation.

Now they are attributing poor performance to contrarianism. Some will undoubtedly say this is just excuse after excuse and wonder what the fund will blame next. Putting that aside, T2 does underline a prescient point worth extracting: sometimes it's painful to be contrarian.

In the letter, T2 goes on to highlight that, "it's easy to deviate from the crowd, of course, but it's much harder to be right - and even harder to be right on the timing."

If a value investor can stomach the near-term anguish (and assuming their thesis is proven correct), they'll make it to that mountain top eventually. T2 gives an example of this with their investment in Iridium (IRDM). While they think the stock is a triple in 3-5 years, they have to hang on through the bumpy ride in the near-term as last month the stock was down 15.1% and the warrants dropped 24.1%.

T2's run of poor performance continues and you can read their take on the situation embedded below in their investor letter (email readers need to come to the site to view it):

For more on that particular stock, head to T2's analysis of Iridium.

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