Here is Part 3 of portfolio management highlights extracted from an interview with Stanley Druckenmmiller in Jack D. Schwager’s book The New Market Wizards. Be sure to check out the juicy bits from Part 1 and Part 2. Druckenmiller is a legendary investor, and protégé of George Soros, who compounded capital ~30% annualized since 1986 before announcing in 2010 that his Duquesne fund would return all outside investor capital, and morph into a family office.
Liquidity, Making Mistakes, Position Review
“The wonderful thing about our business is that it’s liquid, and you can wipe the slate clean on any day.”
Liquidity makes it easier to change your mind and to deal with mistakes. This is why people talk about the “liquidity premium.” Theoretically, this flexibility is worth something. But how does one place a value or price upon liquidity (or illiquidity for that matter)? The Pensioner in Drobny’s book Invisible Hands has some interesting thoughts on this.
Our next point on liquidity has to do with a comment that Seth Klarman made about “re-buying the portfolio each day” and the related implications (of opportunity cost, hurdle rate, etc.).
For example: Prices in the marketplace are constantly shifting. Does your portfolio currently offer the best risk-reward profile given present market conditions, or can you improve it by buying or selling certain securities/assets? Mariko Gordon of Daruma Capital has some really interesting insights on portfolio review, decluttering, and improvement (made possible by liquidity).
Remember, investors of private assets do not have this luxury – so take advantage of liquidity wisely.
Sourcing, Liquidity, When To Buy
Q: Did you have any difficulty putting on a position of that size? A: No, I did it over a few days’ time. Also, putting on the position was made easier by the generally bearish sentiment at the time.
People often say that historical returns are not indicative of future performance.
Well, this is also true for trading liquidity: historical liquidity levels are not indicative of future liquidity.
Liquidity is not stagnant! What is liquid today may not be liquid tomorrow, and vice versa. This is why I find it funny when people reference historical trading liquidity. I’ve seen securities seesaw from trading a miniscule 30,000 shares a day, to more than 1MM shares a day.
Also, to Druckenmiller’s point, the time to buy (or sell) is often when there’s a liquidity imbalance somewhere in the marketplace. Liquidity imbalances have the ability to drive prices down (or up).
Volatility, Catalyst, Liquidity
“…I focus my analysis on seeking to identify the factors that were strongly correlated to a stock’s price movement as opposed to looking at all the fundamentals. Frankly, even today, many analysts still don’t know what makes their particular stocks go up and down.”
“I never use valuation to time the market…Valuation only tells me how far the market can go once a catalyst enters the picture to change the market direction…The catalyst is liquidity…”
Look for reasons behind price movement (volatility), such as liquidity imbalances as mentioned above.