There is a healthy sense of skepticism among investors when faced with websites, blogs, newsletters, conferences and other sources of information that claim to offer investment ideas. After all, good investment ideas are valuable and rare. Why would anyone willingly share actionable ideas with others when doing so in a competitive environment could eliminate the opportunity? After all, even for successful paid sources of information, the profits to be made selling ideas may pale in comparison to the profit of keeping an idea to yourself and committing capital to the opportunity.
Whitney Tilson, writing in his annual letter (pdf) to partners of his hedge fund, explained his motivation for sometimes going public with his analysis. Last month, Mr. Tilson published an article on Seeking Alpha regarding his short position in Netflix which prompted a response from Netflix CEO Reed Hastings. Mr. Tilson’s comments regarding why he chose to communicate in this situation appear to have broader applicability:
It’s not for marketing or ego reasons, nor is it an attempt to move stock prices so we can exit at a better price – we are value investors, not traders, and harbor no illusions about our ability to move markets. Rather, it helps us make money, in four primary ways:
1) It helps clarify our thinking to put our investment thesis in writing, especially on complex and controversial positions. For example, on June 11th we published an 11-page analysis (www.tilsonfunds.com/BP.pdf) of why we were buying BP’s stock amidst the panic at that time (it was then at $33.97 and closed the year at $44.17).
2) When it is widely known that we have a position in a particular stock, we often hear from other investors who share valuable information or analyses.
3) Invariably, some people have the polar opposite view of a particular stock and, in sharing it with us, they can help us identify things we might have missed in our analysis. If information or analyses exist that would cause us to change our view, we want to hear about it!
4) When we share our ideas, it creates reciprocity and others share their best ideas with us.
Apparently these positive aspects of sharing information outweigh the potentially negative impact of sharing the analysis. For example, when Mr. Tilson published his analysis of BP in June, he took the risk that the response may have pushed up BP’s share price which could have prevented him from building up his position as the shares continued to drop in the subsequent weeks. After all, Mr. Tilson’s track record has easily exceeded market benchmarks over the past decade and investors pay attention to his views.
Value Investors Exploit “Time Frame Arbitrage”
In a traditional arbitrage situation, an investor exploits temporary differences between the price of similar or identical securities in situations where some type of catalyst will soon occur to correct the pricing anomaly. While there are all sorts of different arbitrage opportunities ranging for commodities to merger risk arbitrage, typically such opportunities are exploited rapidly.
Value investors, while also sometimes participating in traditional arbitrage opportunities, have the additional advantage of practicing “time frame arbitrage”. Most professional investors have extremely short time horizons because they are measured against benchmarks on a quarterly or annual basis. Individual investors, while lacking external pressure to hit short term benchmarks, usually impose such limits on themselves encouraged by prevailing Wall Street sentiment.
This type of thinking allows value investors to participate in opportunities that could take several quarters or multiple years to play out. As an example, consider an investment that could be made today that has an excellent chance of appreciating by fifty percent over the course of two years but could very well underperform the market in 2011. This opportunity may not be very attractive to a manager who cares about beating a benchmark in 2011. Indeed, such a manager could very well prefer an investment that appreciates by ten percent a year for the next two years if that would clear market benchmarks even though the ultimate result would not be as lucrative.
Seeking Contrary Opinions
No matter how thorough the research process, it is always possible that even very experienced analysts will miss one or more key facts that invalidate an investment thesis. Many investors collaborate with a close circle of colleagues and independent thought may be encouraged. However, exposing an investment thesis for a wide audience to dissect can attract contrary points of view that may be missed by like minded people who work together closely.
Charlie Munger often speaks about “destroying your best-loved ideas”. The point is not to lack self confidence in your analysis but to be open to contrary evidence that may have been missed and could lead to a different conclusion. Sharing ideas widely is a great way to attract this type of contrary opinion. Of course, ill founded criticism or attacks are often found on message boards and investment websites and an investor must be able to separate valid criticism from the “noise”.
Perhaps the most compelling reason to share ideas is the reciprocity that often occurs as a result. As Mr. Tilson points out, some investors have shared their best ideas with him as a result. Reciprocity is a basic human tendency which has been described in detail by psychologists and discussed at length by Robert Cialdini in Influence: The Psychology of Persuasion. While the reciprocity tendency can be used in unethical and questionable ways, the basic human tendency is helpful for those who are interested in a fair exchange of ideas with other investors.
Value Investing Congress — West
The Value Investing Congress is a good opportunity to gain insight into the decision making process and investment ideas of a number of prominent value investors. At past events, some presentations had a major impact such as David Einhorn’s bearish thesis for St. Joe at the October 2010 Value Investing Congress in New York. Readers of The Rational Walk qualify for a $1,700 discount for the Value Investing Congress to be held in Pasadena, California on May 3 and 4. The discount expires on January 20, 2011. Disclosure: The Rational Walk receives a referral fee for registrations generated by this promotion.
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