An article in
The Wall Street Journal
last week about the travails of many hedge funds had a paragraphthat summarized the opportunity we believe exists:
All’s not lost for hedge funds, however. Survivors of 2008’s market tsunami likely will enjoy lucrativeopportunities amid much less competition. As many as half the hedge funds that began 2008 could close,or be short of cash, as the new year unrolls. Those with cash on hand and a stable investor base will beable to take advantage of bargains in stocks and various debt markets.
Overview of 2008
It was an extraordinary year – so much so that we suspect we will tell our grandchildren about survivingthe Great Bear Market of 2008. In our 2002annual letter , we wrote that “there were few places to hideas the bear market extended to stocks of nearly every type” – and this was even more true last year.Fortunately, however, we’ve added shorting to our toolkit since then – and, as we discuss below, it madequite a difference.In 2008, the Nasdaq had its worst year since its inception in 1971 while the Dow and S&P had their worst years since the 1930s. The S&P had its 3
worst year ever going back to 1825, as the chart inAppendix A shows. In total, an estimated $7 trillion of U.S. stockholder wealth evaporated in 2008.Even more remarkably, the U.S. was one of the
performing markets in the world, as the averagedeveloped country market (excluding the U.S.) fell 45%, while emerging markets plunged an average of 55%. Japan had its worst year ever, down 42%, while the popular BRIC markets (Brazil, Russia, Indiaand China) tumbled 41%, 67%, 52% and 65%, respectively. Worldwide stock market losses wereapproximately $30 trillion. The average long-short hedge fund was down 26% through November.Market volatility was unprecedented. After Lehman Brothers sank into bankruptcy in September, theS&P 500 had moves of at least 5% on 18 days, more than the 17 such days in the previous
.To shed light on how the market turbulence impacted our portfolio in 2008, we’d like to focus on threestories that summarize the year: a home run, a costly error and a question mark.
A Home Run
As noted above, we correctly identified the housing bubble and anticipated its bursting, so we avoidednearly all long investments in the real estate and financial sectors and aggressively shorted stocks inthese sectors and beyond. In total, we profitably shorted a wide range of stocks during the year, 23 of which contributed more than 50 basis points of performance during the year vs. only one that cost usmore than 36 basis points (Usana, 59 bps). Thank goodness we did so or 2008 would have been a totaldebacle.As discussed on the next page, we profitably shorted stocks in a wide range of sectors, but the singlegreatest concentration was in the financial sector, where we had profitable shorts among the bondinsurers (Ambac and MBIA), GSEs (Fannie Mae, Farmer Mac and Freddie Mac), investment banks(Bear Stearns and Lehman Brothers), large banks (Bank of America, Wachovia and WashingtonMutual), regional banks (Regions Financial and Zions Bancorp), REITs (Boston Properties, GeneralGrowth, Macerich and Simon Properties), mortgage insurers (MGIC, PMI and Radian), as well as AIG,Allied Capital, Capital One Financial and Moody’s.