Secrets of a Hedge-Fund Life

Editor's note: In a volatile market like this one, avoiding knee-jerk reactions is a major challenge. That's why we're sharing a few key secrets from our colleague Whitney Tilson. In this essay – which originally appeared in Whitney's free daily newsletter on June 20 – he talks about the value of long-term investing... and the lessons he learned from managing other people's money.

I have no plans to ever manage anyone else's money again...

But if I did, I would make it a lot easier on myself (and more profitable for my clients).

After nearly 18 years of managing a number of hedge funds and mutual funds, mostly for a couple hundred high-net-worth individuals, I closed my funds in late 2017.

I now share my insights with more than 100,000 readers every day. The stress and headaches in my work have dropped by about 90%.

But if I were to return to managing other people's money, I believe one strategy offers a good chance of beating the S&P 500 Index over a long period of time...

I might call this strategy "10 for 10": Buying only 10 stocks and having an average holding period of 10 years.

(Before I go further, I know that everyone's personal financial situation is different... There's no one-size-fits-all approach. I'm simply discussing the power of this hypothetical "10 for 10" model.)

This strategy would also mean replacing no more than one stock a year on average. And it would involve very little rebalancing. That's because the key to long-term investment success is letting your winners run.

Many studies and my own experience show that most of the gains in any portfolio come from a small number of big winners. So I would expect most of the gains of this hypothetical 10-stock portfolio to come from maybe two stocks – but you sap their power if you're continually taking cash out of those positions.

To see what this looks like, let's take a look at the 10 largest positions in my hedge fund at the end of 2012...

Keep in mind that these aren't current holdings. I eventually unwound my portfolio when I closed my funds to become a publisher. [Editor's note: Prices were current in June when this essay was originally published.]

If I had just gone on vacation for the past dozen years and never looked at my portfolio, I would have made nearly 10 times my money and crushed the market.

So what are the lessons here?

To repeat, your overall returns will only be driven by a few stocks... So you must let your winners run.

Had Netflix (NFLX) not been in this portfolio, the average return would have dropped by two-thirds to 248%, trailing the market. And removing Apple (AAPL) as well would have resulted in a mere 154% return.

Second, the more trading you do, the lower your returns will be. (Many studies across many years and millions of investors confirm this.)

Lastly, you never know where the big winners (and losers) will come from.

My four biggest positions were up 127% on average. My four smallest were up 373%... and included my third- and fourth-best performers.

The lesson here: diversify. Don't go crazy overweighting your favorite stocks – you need to temper your conviction with the humility to recognize that some of your second-tier ideas might be the best ones.

I'll give you an example of this kind of approach...

My friend Chris Stavrou, who ran a small hedge fund called Stavrou Partners for decades, bought A-class shares of Berkshire Hathaway (BRK-A) back when he was a stockbroker in the 1970s.

Chris started buying it for his clients at around $400 a share, even after it had risen more than 2,000% over the previous decade, because he didn't fall into the "I missed it" trap.

A decade later, he opened up his own hedge fund. By then, Berkshire was trading at an all-time high of $1,800 per share.

So did he say to himself, "Wow, this stock has moved up a lot – I think I'll wait for a pullback" or "Drat, I missed it"?

No. He saw that it was a great company run by a brilliant investor, and the stock was still attractive at $1,800. So he bought it for his nascent fund...

And then he did something even more important than buying the right stock: He didn't sell!

Chris didn't sell when Berkshire shares soared past $5,000, $10,000, $25,000, $50,000, $100,000, $250,000, and even $500,000. [Editor's note: They closed Monday above $689,000.]

He didn't sell even when the stock grew to become more than 50% of his fund.

And he didn't sell when he closed his fund (he distributed the stock in kind to himself and his investors).

To this day, long into retirement, Chris still owns the BRK-A shares he bought a half-century ago.

And it wasn't just Berkshire – Chris still owns a handful of stocks he bought long ago, like insurer Progressive (PGR) and Microsoft (MSFT), in which he has made more than 100 times his money.

So the lesson here isn't to never make a trade – adding the right stock can significantly improve long-term returns. But for the best results, I would trade very infrequently.

The key to all of this, of course, is picking the right stocks. And here at Stansberry Research, that's what my team and I aim to help you do.

Regards,

Whitney Tilson

Editor's note: Until midnight tonight, our firm is reopening "The Whitney Tilson Experiment." This new strategy has beaten the market by up to 10-fold since it first went live behind the scenes... And now, we've opened the doors again – starting with Whitney's four newest recommendations, designed for the recent market shake-up.

We're inviting you to claim one free year of access and a full suite of bonuses. But you must act today, before this special offer expires... Get the full details here.