Remember all that stuff about hedge-fund manager George Soros making $1 billion by betting against the British pound? Or how about the disastrous interest-rate bet that sank the Nobel prizewinners at another hedge fund, Long-Term Capital? If you're like me, tales of derring-do and derring-don't at the hedgies leave you scratching for clues. Is such high-risk investing any way to build a nest egg?
No. And now I can prove it. For starters, Long-Term Capital's spectacular demise in 1998 pointed to trouble for globetrotting hedge-fund hotshots. Soros and Tiger Management's Julian Robertson both ran aground this year. Indeed, the average hedge fund has been underperforming the S&P 500 for four years. The hedgies, it seems, make investing a lot tougher than it needs to be.
Underscoring that point, one unusual hedgie, Jeff Vinik, has racked up stellar gains by taking an Everyman's approach to investing. Vinik, the onetime manager of Fidelity's Magellan Fund, doesn't touch derivatives, futures or options, generally won't mess with commodities or bonds, and doesn't make macro currency bets. Such high-octane strategies are the purview of many hedge funds, and the reason some of those funds have made small fortunes--out of very large ones.
Yet in four years, Vinik Asset Management has returned 440% after fees, four times the S&P 500. No need to scratch for clues here. Vinik relies on diversification and simple stock picking, which work so well that, at 41, he's just announced that he'll retire at year-end to play with the kids.
Vinik's style is known as GARP--growth at a reasonable price, a fairly straightforward approach. In simple terms it means buying companies whose price-earnings multiple is lower than the earnings growth rate. Think P/Es of 10 to 14; earnings growth of 16% to 18%. There are hundreds of stocks fitting that description most of the time. Vinik scored big by loading up early this year on drug, medical and restaurant stocks while the masses crowded into dotcoms. He says sticking to his style kept him out of the bubble, "a huge factor in our performance."
Vinik relies on cash-flow comparisons, saying they are tougher to fudge than earnings. He avoids slow-growth industries and pays little attention to the overall market. "Adjustments due to our grand view are very minor," he says. "We focus on fundamentals, company by company."
Like a lot of us, Vinik learned that the hard way. His biggest mistakes occurred when he made too much of his grand view. While at Magellan, he famously shifted into bonds one year, only to have stocks surge ahead. The "classic mistake," he says, is taking your eye off developments at individual companies.
Market timing? It works when it occurs naturally, the product of focusing on valuations. "What looks like us timing the market is really us reacting to companies getting too expensive," Vinik says. He's willing to sit with cash at rare times when everything seems overpriced. "The way you lose money is by chasing what's hot," Vinik says. And by making things tougher than they need to be.