An In-depth Look at Stanley Druckenmiller’s Investing Strategy –

Fortune magazine interview 1988

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PORTFOLIO TALK Battening Down for a Recession

By Andrew Serwer Stanley Druckenmiller

February 29, 1988

(FORTUNE Magazine) – In a modest office 35 floors above Manhattan’s Central Park, Stanley Druckenmiller,
34, punches the keys of his Quotron, ignoring the exceptional view. Druckenmiller is portfolio manager of
Dreyfus Corp.’s $500 million Leverage Fund, which has a broad enough charter to keep anybody busy. He
can buy stocks, short stocks, buy bonds, use financial futures, and sell call options. Evidently he has taken full
advantage. The fund was up 11% when the tumultuous year 1987 ended, according to CDA Investment
Technologies of Silver Spring, Maryland; that was more than twice the return on Standard & Poor’s 500-stock
index. Leverage also outperformed the market over the past three years and past five years. Druckenmiller,
who majored in English and economics at Maine’s Bowdoin College, runs an additional $2.7 billion in four
somewhat less adventurous Dreyfus funds. In an interview with FORTUNE’s Andrew Serwer, he explained his
current strategy.

Is your fund riskier than average?

Actually, it has more tools than other mutual funds to protect capital. As professional money managers, we
use leverage with restraint. Very, very rarely would we leverage the fund aggressively. When we
borrow, it’s mostly to short stocks, which is actually a conservative position because we are also long on
stocks.

[The number 1 misconception about hedge funds has to be the leverage factor. The public always think that
hedge funds tend to run risky and highly leveraged trades. But here, Stanley Druckenmiller himself had
explained that is not the case. In fact, hedge fund managers are pretty calculated when it comes to taking a
leveraged position.]

What are your positions now?

Right now we are 50% long in stocks, which is our way of saying that we own them outright. We are 25%
short, either through stocks or financial futures. Some 10% of the fund is in 30-year Treasury bonds and the
balance is in cash. We have been selling off some of our stocks and plan to lower our long position.

That’s pretty bearish.

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We see an economy that’s in a lot of trouble. Auto sales and housing starts are weak — in fact, the entire
consumer sector. The economy appears strong because lagging indicators like capital spending still appear
healthy. What would make us more bullish would be the recognition that we are in a recession. That
would lead to lower stock valuations and buying opportunities.

[Besides market timing, SD has always placed a lot of emphasis onliquidity. Here, the liquidity that SD talks
about is not the free float or how liquid the stock is. Liquidity here refers to the big picture money
movement in the economy.]

How do you know when to short a stock?

We buy stocks if we think a company’s profitability is going to increase dramatically over the next 12 to
24 months. When we short a stock, we expect just the opposite.A stock you should short is also a stock
people have become very optimistic about. Maybe the company has high profit margins and people
have extrapolated these margins into the future. If you don’t believe that, it’s a good candidate.

[This, in my opinion, is the most important part of the interview which gave us insights about Stanley
Druckenmiller’s thinking. When SD places a bet, he looks for a company which has a profit growth
potential in the next 12 to 24 months. In addition, SD does not believe in extrapolating financial numbers
into the future. In the Malaysian market, one of the most popular method that people look at a company is
how wonderful its financials were in the past and then attempt to extrapolate the numbers into the
future. Based on SD’s thinking, it is time to sell when a company trades at rich valuation and when there is
an animal spirit of people extrapolating past numbers far out into the future.]

Which are your nominees?

I can’t name names, but I can tell you that we have short positions in the brokerage and financial services
industry, specialty retailers, and most recently in technology issues.

Where are you placing your long bets?

We’re very high on the farm sector. It’s our feeling that even in a recessionary environment, consumption
of farm products will hold up quite well. And the lower dollar is going to help exports of farm
equipment and commodities. We have a large position in Deere & Co., whoseearnings per share could
double over the next two years. Another farm equipment company we like is Varity, the Canadian
company that used to be called Massey-Ferguson. We also like such fertilizer companies as International
Minerals & Chemical and First Mississippi. I like Caterpillar because of the dollar and Raychem, an exporter
of specialty chemicals.

[Noticed that when SD talks about an investing rationale, he focuses on what makes the stock ticks, not how
wonderful the financial numbers were. It is also interesting here that, SD thinks consumption of farm
products will be okay even in a recessionary environment. That might explain the high valuation of the
plantation counters in Malaysia, because they are defensive in nature. Besides, SD also talks about the
impact of a currency movement on a company’s earnings. This reminds me of the bull run in exporters when
Ringgit began to weaken 3 years back. An investor who is as nimble as SD would have caught the bull early.
On the contrary, an investor who invests based on historical numbers would have bought into Malaysian
exporters on peak earnings.]

So you think the dollar will continue to fall?

It may be bottoming out. Even so, you have a honeymoon period of about a year after the currency bottoms
because sales are still building. Look at West Germany several years ago. The mark stopped falling in
February 1985, but German industrial stocks kept right on booming until June 1986.
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[In investing, studying event history helps. For example, in year 2014, the USD bull run had just began. Many
investors looking at the drastic weakening in Ringgit had thought that the trend will not continue. However, if
one were to study history, the individual would have noticed that a big move in currency normally lasts
about 5-6 years.]

Any other low-dollar plays?

Two more we like are Ingersoll-Rand and Texas Industries, which produces cement and specialty steel in its
Chaparral Steel subsidiary’s mini-mill. Texas Industries’ steel business has been very successful lately and
has gained market share from imports.

What’s your largest holding?

Western Mining, an Australian stock we bought a while ago but still like. The company is primarily engaged
in gold mining, and we think it’s a good hedge against the world economy. Another Australian stock we own
is Bougainville Copper.

What other stocks are you hanging on to?

We hold several stocks in non-industrial areas, such as McCaw Cellular Communications, which builds and
operates mobile phone systems. We think the mobile phone trend is for real, and McCaw has been very
successful at acquiring licenses for low prices. We also have a longstanding position in Capital
Cities/ABC. The management team, one of the best in the country, has done a terrific job of cutting
costs. Cash flow is exploding right now, and we think this will continue even if demand doesn’t pick
up. The outlook for 1988 is good because of the Olympics and the election, which have historically been
associated with higher advertising rates.

[Many people may have thought that hedge fund people always trade based on technicals. Here, in fact, SD
also looks at the fundamentals such as management capability, cash flow etc. as well. So, while timing a
stock is important, the fundamental story of a stock should not be ignored.]

What’s the outlook for bonds?

We purchased our 10% bond position several weeks ago in anticipation of a slower economy. I think interest
rates on long-term Treasuries could move down to between 7.5% and 8%, which is quite a move. Short rates
could drop to 4.5% or 5% as the Federal Reserve tries to prevent a recession in an election year.

Source: http://archive.fortune.com/magazines/fortune/fortune_archive/1988/02/29/70228/index.htm

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