Always Adapt

By Stephen Hester, Chief Analyst, Wide Moat Reseach

"What do you mean they don't want the client's money?" I said in disbelief. Fund managers always want money.

You see, I was the lead due diligence officer at a $50 billion broker/dealer. Part of my job was recommending the right alternative investments (e.g., private equity, real estate, and private credit) to the firm's top financial advisors. Managers from Apollo Global Management (APO) to Blackstone (BX) clamored for our clients' capital.

But not this one.

What I learned from this manager changed how I looked at investing forever. I'll reveal part of it to you in this article.

And it all starts with a guy nicknamed "Izzy."

Soviet Labor Camp to American Stock Exchange

A lot of Israel "Izzy" Englander's family never made it out of Germany in the 1940s. His Polish parents, however, were "lucky" to be deported to a Soviet labor camp after World War II. The family eventually made it to the U.S. in 1947.

It started out as a kid's curiosity about stocks. It led to the creation of a Wall Street titan, and one of the richest hedge fund managers ever.

Englander interned at Oppenheimer & Co. where his future brother-in-law would go on to be chairman. After studying finance at New York University, he landed his first real job at Kaufmann, Alsberg. Englander focused on trading both convertible securities and stock options. If he started out doing something even a little different, this story – and his $72 billion hedge fund – may not exist.

Convertible securities are one of Wall Street's hidden profit engines. They involve a convertible investments, like a warrant or convertible preferred stock, that's valued based on something else. That's usually common stock.

Because they can be complex, convertible securities may not be priced perfectly. Unlike most investments these days, there can be arbitrage and other lucrative strategies tied to them. That was the case for Englander in the 1970s, and it's still true today.

With a little coaching, regular investors can learn to profit from convertible securities. I've included a convertible investment in Wide Moat Research's High-Yield Advisor service that I manage, for example.

The Making of a Millennium

In 1989, Englandar teamed up with Ronald Shear. He met Shear through his seat at the American Stock Exchange. They formed Millennium Management with $35 million in seed money, $5 million of which came from Englander himself. Millennium eventually became one of the best-performing hedge funds of all time.

Millennium was so good, in fact, that they started turning away new investors. They simply didn't have the capacity to take more money and still hit the return numbers they were famous for. I learned all this the hard way when that client's investment was rejected all those years ago.

Israel "Izzy" Englandar's success is legendary. At one time, he bought the most expensive apartment ever in Manhattan.

This begs the question on everyone's mind: What strategy did he use to build all that wealth for himself and his investors? That's the secret. There is no strategy. Not in the traditional sense, anyway.

Always Adapt

Most hedge funds have a chief investment officer that tells everyone what to do. Sure, traders and portfolio managers have some latitude, but they need to fall in line with the main strategy set by the executives. It's no different than working any normal job.

But there is a flaw to this approach. A serious one.

Financial markets change, and what worked yesterday eventually stops working. Many hedge funds put themselves into a box and rely on one approach. Before you judge too harshly, think about you and your friends or family. Think about your own preferences for investing.

I bet some are hardcore dividend investors. There is at least one that cannot resist high-risk technology stocks. You may even know someone who hates stocks because they were burned in 2008 and 2009. Now, they only invest in bonds, precious metals, and maybe real estate.

We all know these preferences aren't strategic. They have little to do with what's really best for today's market. People like what aligns with their personalities and risk tolerance. What's really the best strategy is an afterthought.

The same bias happens on Wall Street. Which is exactly why Millennium takes a totally different approach.

It hires independent teams of traders from all around the world. Its 6,000 total employees trade on over 100 global exchanges. I doubt most people can even name 10 exchanges, much less 100. I can't either. I tried and only got to eight.

Everyone who trades for Millennium must abide by their risk protocols. That's what they have in common. But it ends there, because each team is independent. One might be stocks on the National Stock Exchange of India (NSE) and another might be distressed bonds on one of the seven Euronext exchanges.

There are no preferences, no favored strategies. If it works, it's elevated. If it doesn't... it won't last long.

What We Can Learn from Izzy and Millennium

As a due diligence officer, I've seen more than my fair share of hedge funds. I've been to Millennium's Manhattan offices and visited with several of their teams. I've also been to the offices of a dozen other hedge funds.

In my view, Millennium's approach is one we can all learn from. We should stay "close-minded" about risk management, but open-minded about everything else.

On the front page of Millennium's website, it reads, "Independent decisions." To me, that means, as investors, we should be open to new strategies, markets, and asset classes. After all, the only thing guaranteed is change. And nowhere does that apply more than the financial markets.

No matter what your personal preference is, consider learning about other areas of the market that seem attractive. Investing is hard enough as is. Limiting ourselves to only the areas we feel comfortable is certain to leave money on the table. It could be the difference between reaching our investing or retirement goals and not.

At the same time, think carefully about risk management. I just finished the 2024 performance review for High-Yield Advisor, which will be included in the upcoming February edition.

We've had one loss in the two years the service has been active, and it was less than 10%. Some of that is luck, but a lot of it is because we apply many of the same risk management strategies that I learned on Wall Street.

Good risk management and an open mind are how Millennium built one of the best track records on Wall Street. There is a lot to be said about following that same philosophy.

Regards,

Stephen Hester
Chief Analyst, Wide Moat Research