America is Losing Her Way
A Brief Introduction from Eric Fry…
The last time I saw Daniel Loeb, I was riding in his private jet from Miami to New Jersey. Danny is a fascinating guy – a California surf rat turned New York hedge fund manager.
In other words, he’s not your run-of-the-mill financial type. He came into the business through the backdoor and succeeded on the strength of his talents, wits and determination. He manages $3.4 billion in his hedge fund named Third Point Partners L.P. (For those folks who do not surf or who have never visited the beaches of Southern California, “Third Point” is the most distant of the three main surf breaks in Malibu).
Danny has done very well for himself, but only because he has done very well for his clients. Making money is all his clients really care about. But how he makes money is all that any of the rest of us really cares about. Danny is an “activist investor,” which means that he attempts to influence the results of his investments, rather than passively buying shares of a given stock and hoping for the best.
Often, the actions of this activist investor upset the status quo – annoying those who happen to reside in the crosshairs of his activism. Thus, for example, when Danny found fault with the CEO of Star Gas Partners a few years back, he made his thoughts public…very public. Danny wrote:
“It is time for you to step down from your role as C.E.O. and director so that you can do what you do best: retreat to your waterfront mansion in the Hamptons where you can play tennis and hobnob with your fellow socialites.”
Obviously, Danny doesn’t worry about making enemies. Which is probably a good thing, since Danny has made almost as many enemies as he has made millions of dollars for his clients.
True to form, Danny just published a fascinating letter critiquing the Obama Administration. But Danny’s letter is as much a lament of the current course of America’s econo-political trends as it is a critique of Obama & Co. In short, Danny believes the Obama Administration is making mistakes – this would be the same Obama Administration that Danny helped to vote into office and for which he helped to raise hundreds of thousands of dollars.
I think you will appreciate Daniel Loeb’s investment insights…even if you do not agree with his politics. Please read on:
A wise and frugal government, which shall leave men free to regulate their own pursuits of industry and improvement, and shall not take from the mouth of labor the bread it has earned – this is the sum of good government. – Thomas Jefferson, Writings, 1743-1826
I predict future happiness for Americans if they can prevent the government from wasting the labors of the people under the pretense of taking care of the people. – Thomas Jefferson, Letter to Thomas Cooper, 1802
One of the traditional methods of imposing statism or socialism on a people has been by way of medicine. It’s very easy to disguise a medical program as a humanitarian project. Most people are a little reluctant to oppose anything that suggests medical care for people who possibly can’t afford it. – Ronald Reagan, 1961
You know, there’s a lot of talk in this country about the federal deficit. But I think we should talk more about our empathy deficit – the ability to put ourselves in someone else’s shoes; to see the world through the eyes of those who are different from us – the child who’s hungry, the steelworker who’s been laid-off, the family who lost the entire life they built together when the storm came to town. When you think like this – when you choose to broaden your ambit of concern and empathize with the plight of others, whether they are close friends or distant strangers – it becomes harder not to act; harder not to help. – Barack Obama, Xavier University Commencement Speech, 2006
It is that fundamental belief, I am my brother’s keeper, I am my sister’s keeper that makes this country work. It’s what allows us to pursue our individual dreams and yet still come together as one American family. E pluribus unum. Out of many, one. – Barack Obama, Democratic National Convention Speech, 2004
I think when you spread the wealth around it’s good for everybody. – Barack Obama’s Comments to Joe “the Plumber” Wurzelbacher, 2008
Review and Outlook
As we entered the second quarter of 2010, many measures of confidence and economic activity were showing consistent improvement, leading us to increase our exposures in select undervalued companies that we thought would benefit from a favorable economic environment. Most pundits initially attributed the subsequent turn in the markets and investor sentiment to the Greek crisis, concern over the Euro, the Oil Spill in the Gulf, and vague rumors concerning faltering Chinese growth. However, it is apparent to us that the turning point in both investor and consumer confidence came on April 16th, with the filing of the government’s suit against Goldman Sachs over its mortgage CDO activities.
This politically-laced lawsuit was a tipping point for shaky investor confidence against an increasingly worrisome landscape of new laws and proposed regulations that are perceived by many market participants to promote “redistribution” rather than growth, and are contrary to free market ideals.
As every student of American history knows, this country’s core founding principles included non-punitive taxation, Constitutionally-guaranteed protections against persecution of the minority, and an inexorable right of self-determination. Washington has taken actions over the past months like the Goldman suit that seem designed to fracture the populace by pulling capital and power from the hands of some and putting it in the hands of others.
For example, a well-intentioned government program gone awry is the new CARD Act that restricts banks from repricing interest rates on borrowers who fail to meet their revolving credit obligations. The effect of this legal prohibition has been to force the banks to raise the interest rate paid by all borrowers, to compensate for losses they are now being forced to take on delinquent borrowers. The effect is a redistribution of wealth from people who pay their debts on time to those who do not.
Laws and regulations such as these justifiably raise questions about this government’s commitment to free-market capitalism and the articulated rule of law. Arguably unconstitutional Bills of Attainder, such as the special “Enterprise Tax” proposed to be levied on hedge fund managers and other managers of private partnerships who wish to sell their management companies (ostensibly in order to extend unemployment benefits beyond the current 99 weeks) send a vivid message that this Administration is operating from a playbook quite different from the one we are used to as American business people; a thought that chills all participants in these free markets.
On the other hand, it is not hard to understand the source of the popular distrust in capitalism today. Many people see the collapse of the sub-prime markets, along with the failure and subsequent rescue of many banks, as failures of capitalism rather than a result of a vile stew of inept management, unaccountable boards of directors, and overmatched regulators not just asleep, but comatose, at the proverbial switch. When we hear the chorus of former executives and regulators exclaim that the crisis was “impossible to see coming”, while at the same time walking away with millions or going on to greater levels of responsibility in government, it is both puzzling and demoralizing. It is easy to see why so many people have concluded that the entire system is rigged.
This crisis of trust in our system is not limited to inept executives in regulated financial institutions that bury their shareholders and then walk away with ill-gotten sacks of loot. Having analyzed hundreds of proxy statements from the outside and having had the “pleasure” of sitting on several corporate boards, giving me a chance to walk the sausage factory floor, I have personally witnessed the incompetence of many boards of directors. One can only conclude that the incentive systems put in place for directors reward luck and station more than they do talent, skill or creation of shareholder value.
Not all boards are bad, of course. Private equity firms have a terrific model of appointing energetic members of their firms and outside experts to oversee the affairs of the companies they govern. They tend to have real “skin in the game”, spend days reviewing strategy and other matters, and have their own staffs to analyze numbers produced by the company. Board fees tend to be irrelevant to the members of such firms as they are keenly focused on strategies to deleverage and to create long/medium term shareholder value.
Even some public companies have similarly engaged corporate boards.
However, individuals who rely on the stipends they receive from numerous corporate boards and thus appear motivated primarily to ensure continuing board fees, first-class air travel and accommodations, and a steady diet of free corned beef sandwiches until they reach their mandatory retirement age populate many of the boards we have come across.
All of the above leads us to conclude that America faces not only a crisis of confidence among consumers unwilling to spend and businesspeople unwilling to invest, but also a crisis of leadership. So long as our leaders tell us that we must trust them to regulate and redistribute our way back to prosperity, we will not break out of this economic quagmire.
As capital allocators, it is important to remain dispassionate amid the volatility. We have given a great deal of thought about the impact that public policy has on individual companies, industries, and the economy generally. It was this decision framework that led us to shed our investments in large cap US banks in January due to concerns over increasing regulatory headwinds (in advance of the announcement of the Volcker Rule). We have also sold other regulated industries and eliminated our position in Wellpoint, an HMO that is a statistically cheap stock owned by several hedge funds, but which we saw as being overly exposed to unpredictable government regulation.
On the other hand, our perspective on the government’s increased willingness to use its regulatory muscle enhanced our short positions in the for-profit education space. Indeed, this summer certain government actions taken regarding these companies served to accelerate the unfolding of our thesis on these names.
As we discussed in June’s letter and on our Quarterly Investor Call a few weeks ago, we began to bring our gross and net exposures down significantly throughout May, primarily in our equities portfolio. We continued this process through the remainder of the Second Quarter, carving out most positions without definitive hard catalysts on the equity side, also reducing positions in Europe, and avoiding sectors entirely where US government intervention remains likely. Gross and net exposures in our portfolio today are at their lowest levels since March 2009, and have been decreasing all summer in accordance with our political and economic framework.
One can hope only that this Administration, composed of brilliant academics that have had experience in creating the very regulation and overseeing the very institutions that have failed, has learned from its mistakes and will set us down the right path. Perhaps our leaders will awaken to the fact that free market capitalism is the best system to allocate resources and create innovation, growth and jobs. Perhaps they will see the folly of generating greater deficits by “investing” in programs that lead to corruption and distortions of the system. Perhaps too, a cloven-hoofed, bristly haired mammal will become airborne and the rosette-like marking of a certain breed of ferocious feline will become altered. In other words, we are not holding our breath and are focused instead on navigating these murky waters for the benefit of our funds.