Wisdom from Whitebox's Andy Redleaf


Ever experience those humbling moments when you read something and think: “Wow, this person is way smarter than me” – happens to me every single day, most recently while reading a Feb 2013 Whitebox client letter during which Andy Redleaf & Jonathan Wood devoted a refreshing amount of text to the discussion of portfolio management considerations (excerpts below). Enjoy!

Hedging, Exposure, Mistakes

“The job of the arbitrageur, as we see it, is to isolate the desired element, the desired asset claim, which in turn is usually desirable because it trades at a different price from a similar claim appearing under some other form. The purpose of a hedge in this view is not to lay off the bet but to sharpen it by isolating the desired element in a security from all the other elements in that security.

If we think about it this way, then alternative investing can be defined as owning precisely what the investor wants to own, in the purest possible form. Sadly, owning just what one wants to own is no guarantee that one will own good things rather than bad. But at least a true alternative investor has eliminated one whole set of mistakes – owning stupid things by accident. If the alternative investor owns stupid things at least he owns them on purpose.

The really bad place to be is where all too many investors find themselves much of the time, owning the wrong things by accident. They do want to own something in particular; often they want to own something quite sensible. They end up owning something else instead.”


“Consider, for instance, the stocks of consumer staples companies. Because no one can do without staples, these stocks are often assumed to be insensitive to the economy. And because they are, on the whole, boring companies without much of a story they generally fall on the value side of the great glamour/value divide. Precisely these characteristics, however, recently have caused them to be heavily bought by safety-conscious investors so that as a group they are now priced to perfection…

Throughout markets today the most powerful recurrent theme is the inversion of risk and stability; almost universally securities traditionally regarded as safe and stable are neither. We are less confident in opining that securities traditionally regarded as speculative have now become safe. Still the thought is worth following out… Tech is traditionally thought of as speculative, but Big Tech today is not the Tech of the go-go years. These days Big Tech is mostly just another sub-sector of industrials.”

A great example for why historical volatility is not indicative of future volatility (as so many models across the finance world assume).

Volatility is driven by fundamentals and the behavioral actions of market participants – all subject to the ebb and flow of changing seasons. If fundamentals and the reasons driving behavioral actions change, then the volatility profile of securities will also change.

Diversification, Risk

“Speaking of looking for safety in all the wrong places, diversification is widely regarded as a defensive measure. This is a misunderstanding. Diversification in itself is neither defensive nor aggressive. It is a substitute for knowledge; the less one knows the more one diversifies…In our credit strategies, diversification was the watchword for 2009. We bought essentially every performing bond priced below 40 cents (an extraordinary number of such being available in that extraordinary time). We did this because collective the expected payoff on such bonds was enormous…It made no sense to pick and choose. Making fine distinctions about value in an inherently irrational situation more likely would have led us astray. In that situation diversification, rather than blunting the investment thesis, actually helped us focus on the best on the interesting factor: the market-wide loss of faith in the bankruptcy process.”

I think it's an interesting nuance that diversification itself doesn't necessarily "blunt" the potency of ideas. In certain instances, such as the one outlined above, diversification lends courage to investors to size up ideas without committing to one or two specific firms or assets.

In his 1996 letter, Seth Klarman has discussed something similar, using diversification to mitigate unfamiliarity risk by purchasing a basket of securities exposed to the same underlying thesis and opportunity set.

Diversification, Volatility, Expected Return

“The downside of a concentrated portfolio is that returns tend to be lumpy and dependent on events.”