In many disciplines it’s relatively easy to reflect on mistakes and improve – if you are honest with yourself, you can determine what you did wrong and focus on not repeating your mistake. Investing is not one of these disciplines. Due to the long-term nature of the serious investor’s process, it’s often difficult to objectively tell if you’ve made a mistake until far into the future. We all know one’s process is more important than near-term outcomes – but given each investor has slightly different processes which they cannot a-priori know is right or wrong, don’t negative near-term outcomes shed doubt on the process itself? The stubborn investor with a great process will succeed, but the stubborn investor who thinks they have a great process but really doesn’t will perish.
Imitation of historically proven investment processes is a great approach – you can benefit from years of knowledge that you could not acquire on your own until it’s too late. But successful imitation requires real experience – simply reading the Intelligent Investor or One Up on Wall Street won’t provide the average investor sufficient clarity to make proper investment decisions. This is why apprenticeships are so valuable in the hedge fund business – learning from a good mentor allows the mentee to absorb the mentor’s process and branch from it to match their style as they grow.
I spent ~5 months at Madison, and I tried to absorb as much as I could. Yet sometimes I still struggle to understand if I am moving in the right direction.
Let’s start with an item that’s easy to reflect on.
I attempted to participate in the CMI/ATMU odd lot trade – the trade was simple: buy CMI stock, tender it for ATMU stock at a pre-determined ratio that reflects a discount to ATMU stock price, sell the ATMU stock. Though ATMU lacked borrow, the trade could be hedged via puts such that it is impossible to lose money unless the tender is delayed past the put expiration date. On the day of expiration of the tender offer, I bought around ~$50k of CMI stock and hedged with the necessary number of ATMU puts. I discussed the terms of the tender offer with multiple Fidelity representatives, and they told me to participate, I need to buy CMI stock by 7:30pm EST on the expiration date and call in to tender my shares within the next 2 days. This was wrong – the cutoff time was 3:00pm EST and I needed to submit instructions to tender before the cutoff time (not within the next 2 days). Unable to tender, I was forced to sell my CMI at a loss and left with a near-worthless short ATMU position. Total damage: $1.8k. This loss hurt a disproportionately large amount psychologically relative to the actual monetary damage (60bps). I was furious with Fidelity, as they clearly provided misleading information, but an intellectually honest perspective would surmise that I was also at fault – 1) I should have done more research on tender offer submission instructions (while I don’t know if I ever had the ability to tender my shares and thus if this was a contributing factor to my loss, it is still a gap in process) 2) I should have forced better clarification from the Fidelity representative, even if I may have sounded overly redundant and annoying. I think the trade idea was great here – done properly, it could have ended up being a near risk-free $12-15k gain, but the execution was very poor and could have been rectified by greater attention to detail from me.
After a blown odd lot trade, I was somewhat “tilted” and eager for a quick trade to make up for my losses. Kuppy revealed information that made it clear the uranium market had bottomed, and I rage bought a ton of physical uranium, nearly 1.5x’ing my position. Based on outcome, this seems to have been a great decision (at least so far – only 1 week in). But the process was tainted by emotion and psychological distress from the blown odd lot trade. How do I evaluate the takeaways here? Not too sure. But what I do think is that I should force myself to size positions larger in high-conviction ideas. I’ve always struggled with this, but I think it’s a necessary adjustment I need to make to my process. While sizing up does expose me to additional risk, this risk can be mitigated via stop-losses or in the case of buying long-term positions at attractive prices, by a sufficiently large margin of safety.
I’ve also recently struggled with how strict my criteria should be for entering new positions. I spent time looking at ZENV and IVFH and felt both were trading at discounts to intrinsic value that should close relatively quickly. But I set arbitrarily low buy targets which the stocks didn’t hit and failed to capitalize on the rally towards intrinsic value. In the case of ZENV, my diligence process was slow (and honestly still isn’t complete). But I question whether the rallies in this case were driven by underlying fundamentals or small-cap beta – again, questions of process vs. outcome complicate my ability to reflect. Generally, I think I should be taking on more risk and entering these trades when comfortable, rather than suppressing that feeling in hopes of getting a better price or being more “selective”.
Position sizing and risk management is something I’ve been struggling with for some time and is important for me to get right. Improper position sizing means overexposure to bad outcomes or underexposure to good ones. Striking the right balance is a deeply personal task. I think the optimal position size for me is the largest one such that I am still able to sleep at night (maybe an overused metaphor and cliché criteria, but I do somewhat mean this in a literal sense). I’m not sure if I’ve pushed myself to this limit. In this vein, let’s discuss TSVT – two seventy bio is a recent (2021) spinoff of Bluebird’s CAR-T drug, Abecma, for triple class exposed multiple myeloma (a type of cancer). Nick Leschly, CEO of Bluebird, left the company to lead TSVT. The market quickly realized Leschly was a dreamer – he threw billions into unproductive R&D funding TSVT with dilutive raises and a sale of Abecma ex-US rights at a low valuation. Eventually, an activist, Engine Capital, became involved and got rid of Leschly – TSVT sold off the speculative assets committing to a focus on GoodCo (Abecma) and cost-cuts. Abecma was approved for the 4L+ setting in 2021 – the real value of the asset becomes unlocked if approved for the 3L+ setting – nearly quadruples the addressable market size and leads to better utilization of facilities; there’s a lot of operating leverage at play. TSVT trades at $4-5 and is worth $15-30 if approved for 3L+. TSVT is waiting for it’s supplemental biologics license to be granted by the FDA – ODAC voted 8-3 in favor of Abecma approval for 3L+ and historically, the FDA aligns with ODAC in 90+% of cases (though it’s worth noting that the debate in Abecma’s case around PFS and OS usage is what lead to some of the decisions in the 10% of disagreements. After 3L+ approval, there is strong competitive pressure from Carvykti (another CAR-T therapy for MM), but per Madison’s research, the CAR-T market is shaping up to be a multi-player market and constrained on the supply-side. There is a strong binary bet here on FDA sBLA approval – however, if the FDA does not approve TSVT’s sBLA, Engine capital should pressure for a return of cash to shareholders, seeing that Abecma is likely not profitable in the 4L+ setting. So there’s decent downside protection and tons of upside if this all works out – how should this be sized?
Currently, I own about $12.5k of TSVT – say ~415bps. Is this too little? TSVT feels like the most attractive manifestation of a “shitco” binary bet, but what should the maximum position size for such a bet be? Greenblatt suggests that 10-15 positions is ideal from a diversification perspective – further diversification offers marginal risk reduction. Let’s say our top 3 positions comprise 50% of the portfolio – there’s 7-10 positions left for the remaining 50, so that’s anywhere from 5-7% per position. At the same time, a 3-4x on a ~6% position offers 12-18% in overall % gain – should we aim higher? It’s hard for me to tell – I think I could sleep regularly with a 7-8% allocation (near 2x my current position) especially if that allocation was primarily in my account (as opposed to my parents’). While my parents’ encourage me to treat their retirement money the same as I treat my own account, it doesn’t feel right making concentrated degen bets in their accounts especially given their time to retirement (<5 years in case of my dad).
While reflection is difficult in investing, I do note that writing down my thoughts on paper forces me to develop clarity on my ideas and positions – this is super valuable in helping me generating a plan of action. My process is constantly changing but I hope that over time gradual improvements will compound and lead to positive long-term outcomes.