As hedge funds stumble, sorry is the hardest word

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Say what you like about hedge fund manager Bill Ackman but, after losing around $400 million from an ill-timed bet on Netflix Inc., he was quick to exit the position in April and own up to his mistake. In the wake of Netflix’s disappointing subscriber growth, Ackman said he was no longer able to confidently predict the streaming company’s prospects and “100% ready to admit when I’m wrong.” If only all of the investment community was as willing to disavow dogma when market prices undermine financial theology.

Rising interest rates and surging inflation have laid waste to speculative bets, hobbled pandemic winners, and destroyed trillions of dollars of investor wealth this year. This seismic shift is forcing investors and entrepreneurs to reassess previous beliefs and investments. Hedge fund managers and venture capitalists are suddenly talking a lot about “humility”, and doing plenty of apologising, or at least they should be. “Markets teach. The lessons can be painful,” as Amazon.com founder Jeff Bezos put it.

But not everyone is ready to accept we’re not in Kansas anymore. Recanting is hard because the boom in many risk assets was underpinned by faith: Techno optimism, crypto evangelism, and a conviction that perpetually available cheap money meant forever rising markets have become deeply ingrained.

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For much of the past decade, spraying money at growth stocks, startups and anything crypto-related was a can’t-lose strategy; suddenly, everybody was an investing genius, and they were handsomely rewarded for it.

But the tide of liquidity that inflated those valuations is poised to retreat. Hedge funds are losing money, with Chase Coleman’s Tiger Global Management down by more than 40 percent this year. For startups gobbling up capital without ever turning a profit is no longer a viable strategy: Cash flows, not whizzy growth rates and flattering adjusted profits, matter now.

Following the collapse this month of algorithmic stablecoin TerraUSD, the founder of Galaxy Digital Holdings Ltd. Mike Novogratz was contrite about his investment in Terraform Labs, the company behind Terra and Luna. The failure had dented confidence in crypto, he acknowledged, saying “there is no cavalry coming to drive a V-shaped recovery,” and his Luna tattoo would be “a constant reminder that venture investing requires humility.”

But even with the war in Ukraine and surging commodities suddenly dominating the news cycle, it can hard for professional money managers (or retail investors for that matter) to ditch mental frameworks that have worked so well for a decade.

Some, including Gabe Plotkin’s Melvin Capital Management, which lost billions betting against meme stocks, are giving up rather than trying to earn back investors’ capital. Others don’t seem ready to admit the music has stopped. ARK Investment Management’s Cathie Wood remains wedded to her futuristic pronouncements regardless of the losses her favourite stocks have generated lately.

Although Masa Son says Softbank Group Corp. will be more careful about investing investors’ money after its Vision Funds swung to a $20.5 billion annual loss, his faith in the tech revolution remains undimmed; the recent selloff might even be “the right time to buy,” he said.

A concentrated bet on fallen online used car retailer Carvana Co. caused CAS Investment Partners to lose 43 percent at its hedge fund so far this year. But Carvana still had a bright future, portfolio manager Clifford Sosin insisted at the end of April. “I am not immune to mistakes, and I promise that when I eventually make a doozy I will put it here at the top of this letter,” he told Sosin Partners clients. “In this case, however, I do not believe I have.”
Though it exited scores of other positions, Tiger Global added to its Carvana position in the first quarter. Their investing styles differ, but both firms seem deaf to the mantra that “in price, is knowledge.”

Intransigence isn’t really surprising following such a long bull market. Investors believed the US Fed would always step in whenever markets tumbled and some lost sight of traditional valuation metrics. Laser-eyed crypto investing and Tesla Inc. superfandom resembled something close to religion, and supposedly sophisticated hedge funds neglected the need to — err — hedge.

In fairness, picking stocks is hard: even top fund managers have bad years and the best traders are only right barely half of the time.

However, it’s important that investors reassess old convictions when the macro-environment changes, as it has now. “Previous all-time highs are completely irrelevant.

It's not ‘cheap’ because it is down 70 percent,” the venture capitalist Bill Gurley tweeted last month, encouraging investors to forget those high prices ever happened.

Yet even now, many investment analysts cling to lofty share price targets, hoping stocks will spare their blushes by bouncing back. Meanwhile, unicorns resist lower valuations, despite what the slumping public equity markets scream about the true worth of their company.

Nobody likes to admit they put too much faith in the Fed and chased a frothy market. In investing, as in life, sorry really is the hardest word.