The transcript from this week’s MIB: Jim Chanos on Having an Edge is below.
You can stream/download the full conversation, including the podcast extras on iTunes, Bloomberg, Overcast, and Soundcloud. Our earlier podcasts can all be found on iTunes, Soundcloud, Overcast and Bloomberg.
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This is Masters in Business with Barry Ritholtz on Bloomberg Radio.
RITHOLTZ: This week on the podcast, what can I say? Jim Chanos is a legend in the world of shorting and hedge funds and institutional investing, and this is just a tour de force. If you are at all interested in running a two-sided book as opposed to a long only book, if you want to know what it’s like to be a short seller, how to uncover financial fraud, what it was like to uncover some of the biggest frauds of the past 50 years, whether it was Enron or Tyco or to just go down the list, then you’re going to love this conversation and rather than have me babble incessantly about how much fun it was, I’m just going to say with no further ado, my conversation with Jim Chanos.
I’m Barry Ritholtz, you are listening to Masters in Business on Bloomberg radio. My extra special guest today is Jim Chanos, he is the founder and managing partner of Kynicos Associates, the largest exclusive shortselling investment firm in the United States. It was launched in 1985. He is a celebrated short seller who is known perhaps best for his short sale on Enron about a year before the company collapsed to zero. He is a lecturer and Becton Fellow at the Yale School of Management where he teaches graduate students about financial fraud. Jim Chanos, welcome to Bloomberg.
CHANOS: Good to be back, Barry. Thank you.
RITHOLTZ: It is, I have been looking forward to this a while and I have to begin by pointing out that I don’t know if this is true, you have to confirm this, Kynicos is Greek for cynic, is this right?
CHANOS: Yes, it means the literally doglike, but the Kynicos were a group of philosophers who lived outside of Athens in the Golden Age and they basically were searching for the ultimate truth, they believed in the independence of thought and self-discipline and Diogenes was their philosophical leader, but it is the root of the word cynic in English.
RITHOLTZ: And you’re obviously referring to the Golden Age of philosophy. So let’s talk about the philosophy that led to both cynicism and shortselling, you began your career as a financial analyst at PaineWebber and then Guilford Securities and Deutsche Bank, these tend to be long only firms or their clients are long only, what was it like then when there was a heretic in their midst.
CHANOS: Well, I got into Wall Street, the first Gentleman who hired me in 1980 was completely puzzled as to why anyone would want to work on Wall Street because in ’79, ’80 it was not a lucrative field, it was — we were at the tail end, we didn’t know it, of a 16 year bear market. And so in fact from 1966 to 1982 in real terms, the Dow dropped as much as it did in ’29 ’32.
RITHOLTZ: So flat in nominal times but down 80 percent in real terms.
CHANOS: Yes, it was basically peaked to the thousand in 1966 and bottomed out at 700 something in 82 but as you say in real terms, it was a disaster and so I got a job as an analyst doing deal books, but I was fascinated with the market and always invested whatever spare money I had in the market in college my dad pushed me sort of learn about it. And of the head of retail sales was down the hall so I used to spend my lunch hours and after work talking to him and ultimately he hired me in 1982 to come work at a small firm that he was forming, leaving Blyth Eastman, PaineWebber and forming Guilford Securities so I went there as a securities analyst and that was fantastic.
He gave me latitude to do whatever I want…
RITHOLTZ: Long, short, buy, sell…
CHANOS: My first recommendation was a short sale of Baldwin United.
RITHOLTZ: So we’ll talk a little more about Baldwin United in a few minutes, what was the reaction in the community be it analyst community or typically mostly long only investment community that here is this young whippersnapper and the first report is not just hold or neutral or sell but sell short.
CHANOS: Yes, it wasn’t received very well as you can imagine, but today since the big brokerage firms who were recommending stock were also making a fortune selling their annuities and so…
RITHOLTZ: It was a double payer, so you not only were they placing the stock they were also placing — they were — Baldwin was an insurance company.
CHANOS: They are selling annuities, single premium deferred annuities, they were the old Baldwin piano…
RITHOLTZ: Right. Which — that is sort of like iced tea companies morphing into blockchain companies.
CHANOS: Well their CEO was a charismatic guy he made his mark at the company selling pianos door-to-door and I’ve always said if you can sell pianos door-to-door, you are a pretty good salesman.
So — and Baldwin was the fastest growing financial services company in the United States in 1982, and it was, you know, Fortune’s most admired, blah, blah, blah, blah, blah, a lot of things that we would see later 20 years later in the Enron story were basically indicative of Baldwin back then.
RITHOLTZ: So what alerted you that things were not all kosher at Baldwin piano/insurance as if that alone wasn’t enough?
CHANOS: So I was always — as a young analyst, I had no insurance analytical experience so I had to sort of start at ground zero which I think at the end of the day was helpful for me because I had to learn basically from scratch and it was while I was making phone calls and trying to understand how it was that Baldwin could use insurance company money to do acquisitions that sort of the game that they were playing. I got a phone call on one night I was working late a office and it was it was someone wouldn’t give me their name and said I understand your you’re asking questions about Baldwin United, and I said yes, who is this, and he said it is not important who this is but you should be aware that there are insurance laws of the state of Arkansas, the Insurance Department that are public that you should get.
And click and so…
RITHOLTZ: Arkansas.
CHANOS: In Arkansas and so the next morning I told my boss that and of course, asked if I’d been drinking, and I said, no, I got an anonymous call and we should check it out and we hired a local law firm and it was a treasure trove. It was letters going back and forth from state regulators to Baldwin basically saying they were insolvent that they needed to raise capital immediately and that they would no longer be allowed to use insurance company money to make acquisitions and blah, blah, blah, it was the whole story laid out in public documents.
CHANOS: And so yes, then years later, I was at an insurance conference and I heard the same voice from behind me and it was a well known insurance analyst who at the time was in Chicago and he could not cover Baldwin, his firm would not let him because he looked at it and saw…
CHANOS: And the firm had sold annuities so they told him to shut up and I’ve always kept them anonymous ever since but it was that tip that…
RITHOLTZ: That set you off.
Let’s talk a little bit about some of the fascinating FANG stocks, Facebook Amazon Netflix Apple Google, what doesn’t get met mentioned in that list is Tesla and some people have said Tesla may not be worth as much as its current market cap. You have a slightly different view, what is your perspective on Tesla?
CHANOS: I think the stock may not be worth anything on a pure financial analysis basis, it us, to us it is one of the bellwethers of this market, it is a hopes and dreams stock that the investors have pinned really whatever their expectations are on a future — a green future globally they have put it on this stock and on this CEO who has done a really good job in promoting that very vision.
The problem of course is that it’s an automobile company and it is increasingly having problems making automobiles and soon is going to be facing much more competition from people who do know how to make automobiles.
RITHOLTZ: In fact, every major automobile manufacturer around the world, Europe, Japan, and the United States has come out and said we will have some form of an electric or hybrid vehicle either throughout our line or that’s what our entire line will consist of. So the question is Tesla an actual paradigm shift, are they a game changer the world of automotive or are they a stock that simply you know came up with an idea that everybody else has adopted but there’s nothing unique to the company other than a very charismatic leader.
CHANOS: I think it is a great question, Barry.
I think they were a paradigm shift six or seven years ago when they introduced the Model S and I have always said that the Model S was an important car because musk made EVs, electric vehicles sexy. Right? Prior to that, any type of green vehicle was a compromise.
RITHOLTZ: The Nissan Leaf, the Toyota Prius.
CHANOS: And I know that you are a car guy, Barry, and so you know that and then suddenly you had this Model S which is a car that was aspirational, a car you want to drive up to the country club or to the restaurant valet and everybody wanted one.
And the problem is of course the Model S now is seven years old and finally, finally, the Europeans, and then Detroit and ultimately, Japan, are coming with their vehicles. We have Audi and Jaguar coming this year with very good looking sexy crossover cars. And then near and dear your heart we have Porsche coming out next year, Mission E.
RITHOLTZ: That is a handsome car, I got to say.
CHANOS: Which is a gorgeous car and it is coming out year and is a sports car designed from the bottom up from, I believe their LeMons team and know and so now Tesla is in a scrum, they are going to be competing with well financed operations with good R&D whose technology is probably well ahead of theirs at this point.
RITHOLTZ: They can’t fund themselves by selling flamethrowers every couple of months.
CHANOS: Flamethrowers and hats.
Yes, I mean, we are laughing but that is kind of the problem, right? Because you have a CEOs who is kind of all over the place, we believe actually his passion is Space X. So I think he’s going to actually hand over the reins as CEO at some point in the next few years on and move full-time over to Space X.
RITHOLTZ: Plus the hyper loop and the boring…
CHANOS: Yes, I forgot about the hyperloop.
RITHOLTZ: Supposedly, they are really exploring doing something with that. The Boring Company is testing boring equipment.
CHANOS: Yes, and so there is a lot going on there and then that’s part of — I think that’s part of the allure of the company and its valuation is the CEO, the problem again is that he’s up against serious competitors in his core business and then finally on that, we track executive departures in this list we put up and it is stunning as to how many senior executives have left this company in the last two years on the only two companies that we’ve seen in our history with a similar executive departure pattern were Valeant Pharmaceuticals, a couple of years ago, and a little company in Houston called Enron and it is never a good sign when almost all your senior executives are leaving at the stock price at a high.
It is telling you there is something wrong and I don’t know what it is but all almost all senior executives at Tesla see something and are leaving stock option packages on the table.
RITHOLTZ: What about the idea that some big company maybe it’s a GM comes along and buys them as a rescue package and jumpstart their own EV program?
CHANOS: Well, the problem with that is that GM for example, the reason you would buy Tesla ostensibly is because of technology not because the manufacturing process. Right?
RITHOLTZ: Sure.
CHANOS: The manufacturing process is actually pretty poor, the Model 3, their new car appears to have lots of issues upon production, so you would be buying them for Elon’s vision.
RITHOLTZ: Right.
CHANOS: Or their technology.
RITHOLTZ: A little brand halo also, make you a little hipper than General Motors might be, just using them as an example.
CHANOS: It might be, but the problem is of course, that GM’s Cruise software is now better than Tesla’s autopilot.
RITHOLTZ: And their product is out and they are manufacturing it.
CHANOS: Exactly. And so on and then you have to be careful because again most of this mystique of Tesla is based on one car, the Model S.
RITHOLTZ: Right, which is still a beautiful car.
CHANOS: It’s seven years old but it is — yes, but the Model X was just was lukewarm…
RITHOLTZ: Too expensive for what essentially is a midsize van.
CHANOS: Ad now the Model 3 is maybe problematic and so you’ve got an issue here where you’ve got basically a $50 billion market cap which by the way is almost the same as GM’s and it exceeds Ford’s.
RITHOLTZ: Amazing.
CHANOS: You would be buying a company just as big as yourself to basically lose money and then have a little cache. I don’t see it.
RITHOLTZ: Makes perfect sense. So the other side and let me push back a little bit on Tesla. They’ve completely change the game, they’ve enforced everybody else in that somebody maybe Toyota does a joint venture with them, maybe some other Chinese or Korean manufacturer comes along and says we want a toehold in the US and elsewhere, what is the company worth in a takeover or do you end up in a take under situation?
CHANOS: Well, you are a little late because Toyota and Daimler did do joint ventures with Tesla 10 years ago and sold all their stock.
RITHOLTZ: They did, I didn’t know.
CHANOS: They did in fact, both, interestingly, both of those companies sent teams of engineers to help Elon get the Model S out and so I think that that we’ve only seen this and the problem is or is we just discussed is that the valuation of the company which is $50 billion in equity capital and by the time…
RITHOLTZ: Plus debt.
CHANOS: Plus debt. You’re talking about 60 plus billion dollar total enterprise value, this would sink almost anybody but the very largest companies who would have to finance not only the 60 billion cost but the operating losses so you would destroy hearings of almost any auto OEM by buying Tesla.
RITHOLTZ: Fascinating. Let’s talk a little about hedge funds and how they’ve changed over the years. The last time you and I sat down for a conversation was about three years ago or a recorded conversation I should say. You mentioned that back in the day, there were a few hundred hedge funds and out of those, 20 or 30 were reliable alpha generators. Today there is 11,000 or so hedge funds, how many…
CHANOS: There are probably 20 or 30 right about…
RITHOLTZ: Right, is that – is it still that small a percentage of regular?
CHANOS: You know, it’s I have a little bit of a vantage point because not only am I a manager but I also sit on some investment committees of a reasonably large investment committees so I get to see the pitches. I get to see the pitches and I get to see the results from a lot of people in the industry as someone who allocates capital.
And I have to tell you the industry is wanting and it’s wanting across the board and alphas have dropped including our own overtime whether they been competed away, now one other theory I have, of course, being on the short side is that lower interest rates, particularly for short-sellers have reduced rebate income and so I when I started in 85 if we sold the stock short before anything happened we’re in six or seven percent annually on the cash proceeds, and we split that with prime broker.
And now that number more recently was zero.
RITHOLTZ: Right.
CHANOS: That was a significant sort of source of returns so I think that that’s one aspect particularly for fundamental short-sellers. But look, I mean markets have gotten more and more efficient the more smart people pursuing something, the tougher it is going to be to beat the market, that’s just a given, I think.
RITHOLTZ: The paradox of scale is what my…
(Crosstalk)
CHANOS: And then of course the size, right? I mean we know it’s a lot easier to beat the market if you are running 50 million than a few billion.
RITHOLTZ: Even a few hundred million, there is still some opportunity, but some of these funds are $5 billion and $10 billion and $20 billion, that’s tough to move — swing that around.
CHANOS: The other thing is of course you do stop managing a portfolio, you start managing a business as well and I am always mystified by my peers who have been very successful and are now running, you know, as you say, $10 billion or $20 billion but have 200 to 300 employees. And I just, I mean that just blows my mind. That’s a reasonably large business.
RITHOLTZ: How big is Kynicos these days?
CHANOS: We are the same as we have been for years and years and years, basically about 30 people.
RITHOLTZ: Which is still work to manage but it’s not a full-time job.
CHANOS: It’s not 300. It’s a magnitude of difference.
RITHOLTZ: So given your perspective as both a fund manager and an asset allocator, when you’re reviewing a hedge fund and deciding whether or not you’re going to give them capital, what are you actually looking for? What would make you say this is a place I could park some money?
CHANOS: So some, Julian Roberts said it best that I think to some extent to why the Tiger Cubs have been so successful is what is your edge? And he always — when having a bear and a bull, discuss — debate a stock in his shop, we ran money for him and he would have us come in and talk about one of the shorts, our shorts because someone in the shop may have liked it on the long side.
And he would constantly say what is your edge, what you know that the market doesn’t? And that applies, I think to fund managers generally. What is in your process that gives you an edge whether it’s trading wise, whether it’s research wires that basically sets you aside that you see things differently and you see you see the reality versus the perception of reality.
And so what I’ve found is that numbers can be very misleading because very smart people can struggle and very, very mediocre people can excel for periods of time, it is just not where you want to place your bets.
And so if — as an allocator, if we see someone who we think is really smart and working but has a definable and sustainable edge, that someone that you might want to consider particularly if they are struggling to be allocating capital because reversion to the mean is also a pretty powerful process.
RITHOLTZ: So when you say struggling, do you mean struggling running the fund or struggling in terms of their performance?
CHANOS: Performance, maybe they are not generating the alpha, they are matching the market and or slightly behind the market but yet, you know, have a pretty superior long-term track record, same people doing it, same process, and so sometimes you see — sometimes you see the opportunity do that.
What most people do of course is they just simply look at performance.
RITHOLTZ: Right.
CHANOS: And that alone will not do it for you because you’re always going to chase that which has been hot and it’s so hard to say, well this guy is not doing well, we should be allocating some capital because they are going to come back into favor and by the way, they’re still doing what they’ve always done well. Very, very tough, and then of course you have to disaggregate the beta from managers and that’s essential.
You have to take out the market because we can buy the market for 10 basis points.
RITHOLTZ: Right.
CHANOS: Right? So paying big fees to people who are either matching the market with no edge or leveraging the market to get outperformance is a fool’s errand.
RITHOLTZ: You know, I read somewhere that past performance is no guarantee of future returns. I think I saw that on some document somewhere. Let’s talk about some of those, Conseco, Tyco, Commodore, Coleco, Integrated….
CHANOS: I don’t think your listeners were alive when most of those were…
(Crosstalk)
CHANOS: A little more recent, the more recent ones.
RITHOLTZ: So let me ask a different question then. Tell us about something that in hindsight you looked at and said, why don’t we short that? That’s right in our strike zone. Anything that you looked at and didn’t pull the trigger on?
CHANOS: I think the biggest whiff that we have done work on and took a pass on was Japan in the late 80s. I was sure a lot of commercial real estate stocks in the US in the late 80s, the tax law had changed, everyone have levered up in the commercial real estate to sell it to the Japanese.
RITHOLTZ: Right.
CHANOS: The tax shelter business was recapped by the tax act from 86 and when we looked at what the Japanese were doing we saw them doing all kinds of dumb things and I began looking at the Japanese banks which at the time were the largest in the world and some of the Japanese conglomerates which were the largest in the world and the numbers didn’t make any sense but I felt I had my hands full in US and then what I really missed was a 20 year bear market in these heavily leveraged Japanese companies.
RITHOLTZ: And compared to even the dot com NASDAQ, the Japanese market was far more expensive, far more overstretched than NASDAQ even got at the peak in 2000.
CHANOS: Right, and of course, it got to just insane heights and it is still not scaled on and so I think that that was one of our greatest — our greatest misses fundamentally.
RITHOLTZ: So from Japan, let’s just hop across the China Sea and talk about China.
CHANOS: Yes.
RITHOLTZ: You were very negative on China for a long time before they had a little bit of a hiccup, tell us about the China trade and what you think of the Chinese economy here and that region as an area to invest in?
CHANOS: Well, it’s funny that we talked about Japan because the analog that China eight years ago when we start talking about it most resembled was actually Japan of late 80s, if you think about it, it was a state driven capitalist model that was a better model some thought than the US or the Western model, it was heavily relied on debt, it was heavily relied on a domestic real estate bubble, it was very trade oriented, export oriented, it had a protected currency, it had its own culture, I mean the similarities between Japan in ’09, 2010 and — in China in ’09 2010 and Japan in 1989 ’90 were actually somewhat significant the course everything is different and but when we started looking at China, the FXI which is the eight share ETF was trading around $41, so it is $46 now, so it’s up about, it’s up a little bit more than 10 percent in eight years.
The rest of the markets that we were looking at you know, have doubled and tripled so China has been one of the better places to be short for the past eight years if you are a short seller.
I think that what’s really China is how little has changed in the eight years. Xi Jinping is basically now the Emperor, but the whole concept of, all the stuff you for the last eight years, oh, they’re going to become a consumer driven economy, that hasn’t happened, they are going to reduce investment as a percent of GDP, that hasn’t happened, you know, the currency is going to either go up a lot or down a lot, that hasn’t happened. What is really interesting about China is there is pretty much status quo and the model, the economic model that is China is still the same, it relies heavily on debt.
And so debt is still growing, it is not growing as fast as was eight years ago when it was growing 20 to 30 percent a year, it is now growing 10 percent to 15 percent a year but it is still growing at twice GDP growth, and they can’t get off the stimulus or the steroids if you will of just constant debt injections to build new airports, roads, high-rises, it is still what’s driving the economy.
RITHOLTZ: So what’s the endgame for China?
CHANOS: I wish I knew. It’s fascinating to watch because everybody sees it, when we started talking about it eight years ago, it was a controversial viewpoint, now it’s not. Right? It’s hard to — the debt levels have doubled and tripled.
RITHOLTZ: That 60 Minutes segment on the ghost cities of China, as I was watching, I’m thinking, Jim Chanos has to be turning cartwheels over this.
CHANOS: What is fascinating about that, of course is that the cities that they showed have as the bulls have said, mostly filled up, the problem of course is there are new empty cities.
RITHOLTZ: Another 50…
CHANOS: And this is the inherent problem, right? And so I think that that any time you got a model with credit driven based on a property bubble and in investment now that that is not needed, I always joke that Hainan, the island of Hainan, a tropical island in the South China sea when we started looking at China, it had one international airport. About three to four years later, they completed the second international airport which is not fully utilized today and now they’ve begun work on the third international airport which is just folly.
RITHOLTZ: On that little island.
CHANOS: Yes, that little island.
So this is the problem with an investment (inaudible) all three of those have contributed to GDP, construction dollars go right into GDP, but of course the economic returns and each one will dropped.
RITHOLTZ: I’m going to manual this data point I believe it was you who had either said or written China over the past three years used as much cement as the United States used in the entire 20th century.
CHANOS: I think it was not us, it was it was somebody else, Bill Gates I know pointed it out, I don’t know who the originator of the data point was but I think it was China in the last 10 years has used as much of the concrete as the US did in the last hundred plus.
RITHOLTZ: That is astonishing.
CHANOS: That is true. It’s remarkable to look at what China since it entered the WTO in 2001 has done, and it has done so, it has done so and has literally transformed the country in less than 20 years. The problem again of course, that that the Bears will keep pointing to is you pulled a lot of it forward, any time you use debt to fuel your growth you’re basically pulling forward consumption and that is just an economic remedy.
And so there will be a reckoning at some point the debts do have to be serviced or inflated away and then one of the two will happen.
RITHOLTZ: So let’s talk about a few other topics that I really enjoy your perspective on. We talked about hedge funds earlier, I’ve been reading a decent amount about private equity and they’re being challenged in terms of are they really generating the sort of above market returns they claim, they’re doing a little bit of let’s just call it creativity. So when you — for those who are unfamiliar when you make an investment in private equity, you’re committing capital but you’re not actually giving them capital so you more or less have to sequester that. They calculate their performance based on literally when the money hits which could be 2, 3, 4 years later that you’re sitting with capital tied up that’s not yet working, theoretically, it’s in a short-term fixed income fund.
What’s your perspective on what’s going on with private equity? I assume you allocate on some of the boards you sit, money into that space.
CHANOS: We do, and some of my best friends and clients are in private equity so you know, look, I always tell them I’m jealous of — you know, they have a great business model and they are one of the — the two areas in investment management where nobody’s questioning fees and/or returns are venture capital and private equity.
RITHOLTZ: Right, and remember Bain Capital and Mitt Romney, there was a lot of reports about have — did Bain exaggerate its returns and that sort of what started this whole cascade over the past…
CHANOS: You know…
RITHOLTZ: …six years.
CHANOS: I think that the issue is a broader one which is if you are investing in venture capital and private equity, I would just tell investors, understand that in the case of venture capital, you are investing in high beta — high risk high return situations. So a venture capital fund should be measured not against the S&P but against some high beta you know…
RITHOLTZ: Micro cap.
CHANOS: Whatever, yes. A small-cap high beta fund. Private equity is a little bit different, right? Because all the private equity funds are different but they do lever and so at the end of the day, a private equity fund should have multiples of return of the S&P if you’re using leverage. I believe they don’t and so that’s — that examination and hedge funds began this, you and I both know, people began kind of wondering about hedge funds after ’08.
RITHOLTZ: Right.
CHANOS: The Golden age of hedge funds was 2000 to ’02, that’s when the markets went down and let’s not forget the 2000 ’02 was worse than ’08 for the stock market, the S&P went down 40 percent, NASDAQ went down 80 percent.
RITHOLTZ: Yes versus ’08 with…
CHANOS: 40, basically 40 for everything.
RITHOLTZ: (Inaudible) the S&P is down about 57 percent but NASDAQ didn’t get nearly as shellacked in ’08 as it did. That was a concentrated 32 — 29 to 32 like collapse.
CHANOS: Yes, it was. And that is where retail investors were.
And hedge funds missed that, right? They in fact — a lot of them made money in that period, they were short the garbage and long value, and value…
RITHOLTZ: Between 2000 and 2003.
CHANOS: And then — and that performance ushered in the golden era of inflows from ’03 to ’08. And then hedge funds didn’t, they didn’t basically hedge, they didn’t protect you in 07, 08 and from there on in people began to look at them differently and scrutinize them and look at the alphas and kind of disaggregate the results and hedge funds have had a basically rough go of it ever since of justifying their existence.
Private equity has not had that.
RITHOLTZ: So to be fair to hedge funds, I think the peak to trough returns according to some of some of the peak to trough returns for some of the indices or something like down 29 percent in a year when the markets were down 38 percent which is good on a relative basis but sure as hell is an absolute return.
CHANOS: Well, and then in the end, they performed on the way back up, that’s the problem.
RITHOLTZ: That was the giant up 6 percent to 8 percent and then when the market….
(Crosstalk)
CHANOS: Yes, so stay for the, you know,…
(Crosstalk)
RITHOLTZ: Come for the high fees.
CHANOS: Come for the high fees and losses and then stay for the performance on the snapback.
(Crosstalk)
RITHOLTZ: You know, I get a nickel every time somebody says that which is fascinating.
CHANOS: So buy you get my point and I think private equity which has seen the short sharp recessions, you know and then easing by the way of monetary policy over their life, private equity really has seen nothing but lower rates over its goal there.
What happens if asset prices don’t go anywhere and rates go higher for the next generation.
RITHOLTZ: I’m going to guess they are in trouble.
CHANOS: I would guess that, well I guess that — well, I guess that they may not be in trouble…
(Crosstalk)
RITHOLTZ: I mean their returns will be…
CHANOS: The hoped-for returns that the pension funds and endowments and sovereign wealth funds would just constantly just assume private equity is going to earn them 10 percent to 12 percent somewhat uncorrelated, and sort of boggles my mind, it is the ultimate correlated asset theoretically.
RITHOLTZ: Can you stick around a little bit? I have a bunch more much more questions for you.
CHANOS: I can stick around as long as you’d like.
RITHOLTZ: We have been speaking to the Kynicos Associates, Jim Chanos, if you enjoyed this conversation, be sure and check out our podcast extras where we keep the tape rolling and continue to discuss all things shortselling.
We love your comments, feedback, and suggestions, write to us at MIBPodcast@Bloomberg.net, you can check out my daily column on BloombergView.com, follow me on twitter @Ritholtz, I’m Barry Ritholtz, you are listening to Masters in Business on Bloomberg Radio.
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RITHOLTZ: Welcome to the podcast. Jim, thank you so much for doing this, I have been looking forward to this for a while, I have so many questions we didn’t get to and only a finite amount of time and want to get to my favorite questions I ask all of my guests.
But let me just go through one or two questions that I have to ask.
So you’re a fundamental guy, you do not engage in technical shorting, you’re not looking at trend breaks or support failures or any of that sort of chart reading?
CHANOS: I’ve never been able to do to make any money by looking at charts and so I don’t think it’s a strength, I don’t think I have any edge…
RITHOLTZ: No edge, it comes back…
CHANOS: So you know…
RITHOLTZ: And what about the quantitative side, I know you’ve talked about a lot of data but you guys use data at Kynicos?
CHANOS: We like everybody, you know are looking at factor based the investing in the and what factors are driving our stocks one way or another.
The problem of course with using fact-based data on price performance and not on research and we will get to that in a second is that the Third Circuit is that of course by the time you analyze the factors, they become self-defeating and we have a quantitative hedged version of our short fund back in the mid-90s and we realize this even back then that all the factors we were extracting from the portfolio, they didn’t last that long and I bet you now, I don’t know for a fact but I think that these fact-based observations cancel themselves out even faster and if we look at the returns some of the algorithmic funds in the last few years I think that bares it out.
RITHOLTZ: So we mentioned earlier Enron, you have had a very good relationship with reporters and media, I have to mention Bethany McLean who’s work I have always loved and who was right there in the middle of Enron. How has the media worked with you over the years, how have people reached out to you whether it’s an analyst sort of calling late at night, what is your relationship with the press?
CHANOS: Well I mean I think that the reporters generally like talking to short-sellers because they are going to get to get the opposing point of view typically on a situation.
RITHOLTZ: No cheerleading.
CHANOS: Look, thousands of people gainfully employed making a lot of money were there to promote stories, right? Whether it’s PR firms or whether it’s analysts, whether it’s bankers, who are always going to tell you why something is fantastic, there’s only a handful of people who are economically motivated to say, you know, wait a minute, hey, but, you know, this class might be half-empty not half full. And so, you know, most journalists I know that we talk to have been talking short-sellers for years and then just understand they are going to get the other side of the story. It might not be right by the way but at least they will hear a reasoned opinion as to why maybe the stock is overpriced and not underpriced.
RITHOLTZ: And a couple of quotes of yours I would be remiss if I did not mention. “In investing you can be really right but temporarily quite wrong.” What is that experience like?
That can’t be fun?
(Crosstalk)
CHANOS: It’s not only not fun, it is constant, I mean…
RITHOLTZ: Is it?
CHANOS: Well keep in mind, when we started our fund when the Dow was 1300, our original short only fund. So this has been basically 30 years of not only up equity markets but lower interest rates. And I don’t think people, appreciate just what an amazing tailwind most investors have had for the past 30 or 40 years, it is unlike almost anything we have seen in American financial history. And so this is people have gotten very, very used to this, if you’re a short-seller, you have gotten very, very used to basically coming in every day and struggling, I mean just that before anything happens more likely than not the stocks you are short are going to be up.
And so you better be right, you better be right in your fundamentals and you can often be early and often the things that the short-sellers see that become really important, nobody cares about until the company acknowledge itself that it’s a problem.
So take a look at Valeant Pharmaceuticals, one of our celebrated shorts from a few years ago. We started shorting that at $130 before it doubled to $260, and then it went down a lot and it went down fast but the things we saw back in 2013 and 2014 didn’t come to the floor until 2015 and then in late 2015 and the company finally have a realize or admit that it had been some real issues.
That is pretty maddening and painful.
RITHOLTZ: I remember the Enron peaking and I’m doing this from memory so 86 or somewhere in that range on it might have been the Bethany McLean article…
CHANOS: It was right before.
RITHOLTZ: It took a year for the stock to collapse, it fell so slowly it looks like a binary outcome, hey either this company is a fraud or it’s not that doesn’t mean he goes from 86 to 75 to 60 it should be zero or 86 not anything in between, it was a full year to collapse.
CHANOS: I hate to burst your bubble there. Enron was one of the easiest shorts we ever had.
RITHOLTZ: Really?
CHANOS: Yes, we started shorting in the 60s it did run the 80 in January of 01 on the Blockbuster announcement, the Blockbuster that they are getting into business with Blockbuster video to stream video. Now it was a wonderful announcement, the problem was they booked profits instantly on the announcement and even kind of got the technology right, it’s now of course Netflix.
RITHOLTZ: Well, but there wasn’t streaming Netflix for another dozen years so it looked a little bit like a like a fun announcement, there was no real technology.
CHANOS: It didn’t exist yet and so it was still on the drawing boards and then the Bethany’s story came out in February of ’01 the stock basically kind of went 80 to zero in the next nine months but there were some, of course gut wrenching rallies along the way.
RITHOLTZ: Along the way.
All right. So let’s jump into some of our favorite questions that we ask all of our guests. Tell us the most important thing people don’t know about your background?
CHANOS: Well I was premed in college for about three days on and so they got me moving toward the world of finance.
RITHOLTZ: Who were some of your early mentors?
CHANOS: So I was lucky when I got into the business, the fellow that hired me away from Blyth Eastman PaineWebber, a guy named Bob Holmes was not only a mentor but he stood behind me in kind of the darkest days of Baldwin, the stock had doubled, the New York partner was screaming for my head on a plate, I was 25 years old and he stood behind me, you’ve seen the work, you have seen documents, he said, kid, you are right, you are right. Go ahead and publish again with the second report out.
RITHOLTZ: Wow, after it doubled.
CHANOS: After it doubled and just reaffirming everything we had, laying out all the documents we had, all the case we had, and he was the guy who kind of taught me about courage and you know, courage or convictions but he was my boss as well so it was important kind of lesson.
When I moved to New York in ’83, I had a number of wonderful, wonderful mentors who sort of introduces Midwestern kid to New York City and Wall Street itself, you know, people like Stephen Peck, Weiss Peck and Greer who passed on a few years ago and just kind of took me under this wing, and you know, kid, we’re going to (Rayo’s) on Tuesday night and I’m going to introduce you to everybody in town and he was tremendously, tremendously important man in my growth on Wall Street.
You know, and then there were sort of my contemporaries, an old friend, Jim Grant who is on the journalistic side who of course is ancient, he is much, much older than I am.
RITHOLTZ: Like 34 years suddenly.
CHANOS: He is going to kill me…
(Crosstalk)
RITHOLTZ: He is early 80s now, right?
CHANOS: He is about 10 years older than me, but he started his firm in ’84, I started mine in ’85.
RITHOLTZ: Right.
CHANOS: So we both were struggling entrepreneurs trying to get our businesses off the ground in the mid-80s, both of us were sort of skeptics. He had a pen in his hand and I have clients money.
And I think we commiserated a lot and learned a lot from each other way back then.
RITHOLTZ: So I think bowties age people. A lot of folks don’t know, Tom Keen is 29, that’s what a bowtie will do to you.
Tell us about the investors who influenced your approach to investing to shorten?
CHANOS: You know, so probably the investors, two stand out again both people I met early in my career. One of course was that of the legendary Julian Robertson who is of course, still around, still investing, and his approach was something that sort of really galvanized me you know, when I ran money for him and he called me up and say, Jim, I see we are short XYZ Corp. You know, some guys in my shop like that, why don’t you come over for lunch, we will talk about it?
And so it was always like going into the lion’s den, right? Because Julian will be at one end of the table and then there be a bunch of his analysts, many of whom are now legendary investors in their own right.
RITHOLTZ: Right.
CHANOS: Sitting around the table and we argue back and forth over whatever stock it was and you know, what about this, what about this?
And you better know your story because they knew their story. Often, they agreed with me by the way and sometimes they didn’t but you had to hone your craft pretty well to understand again what is your edge what didn’t investors know?
And then another one who is no longer with us who was also a bit of a mentor about New York as well was the legendary short seller Bob Wilson. Bob and I would have lunch from time to time every few months and then he had these wonderful dinners with Dick Gilder, you know, sort of every few months as well and I was privileged to attend those.
But Bob also had one of the greatest quotes of all time that I never forget about investing and I was grumbling about someone who I worked with at Deutsche Bank of the time, and this guy was one of the world’s worst investors, everything he touched went down and he was a long investor and I was always grumbling because the guy was only just making a complete fool of himself in research meetings and internal meetings and Bob looked up at me over his cup of coffee or tea and just smiled, he has a great little sort of devilish smile. He said, Jim, just remember, someone who is always wrong is just as valuable as someone who is always right.
RITHOLTZ: Just take the other side of the trade, that is fantastic.
Let’s talk a little bit about books, this is everybody’s favorite question tell us about some of your favorite books, fiction, nonfiction, market related, not…
CHANOS: So I read a lot of history and it’s my thing on not just financial history but broad history so there always, there is a handful books I always recommend to people if they haven’t read them. One of my favorites and one of my favorite historians is William Manchester and everybody remembers his MacArthur biography and his Churchill’s — his unfinished Churchill trilogy, I think his daughter may have finished it for him, but the book that is utterly one of those game changer books if you read history is a world lit only by fire which is the story of the late Middle Ages in the early Renaissance and Reformation and written through this prism of great people like Magellan and Martin Luther and the Borgia popes and Gutenberg and then basically if it’s a sort of sets the stage for modernity and he tells the tale in the ways only he can. It is just wonderful history. I recommend it highly to…
RITHOLTZ: A World Lit Only By Fire.
CHANOS: Right. And then in business books I’ve always been in my class always loves my history of fraud class, we love of the Match King by Frank Partnoy, which is voted best business book I think it 09.
RITHOLTZ: Right.
CHANOS: And it is just a wonderful story of the greatest fraudster of the 1920s, Ivar Kruger who built this enormous empire on the back of raising money for European countries on the back of a match monopoly and how he became greater than J.P. Morgan by 1928 and basically dragged down mostly European banking system with his collapse in 1932.
RITHOLTZ: That’s fascinating I love Pornoy’s work, he did Infectious Greed, and then he did Wait, which is a fascinating psychological…
(Crosstalk)
RITHOLTZ: Tell us about a time you failed and what you learned from the experience?
CHANOS: Well, we’ve failed all kinds of things and whether it’s single stock ideas, I mean like anybody else, we’re wrong a lot of times. In the short side, you have to be of course mindful of this so whether it’s Valeant doubling on you or America Online which went up eight-fold on us from 10 to 80. And then of course we got out and then Time Warner bought them and we never got back in which was a really good lesson, because it was a lesson not only humility and timing but it is a lesson on risk management.
In that case it didn’t carry us out because we kept the position very, very small over the course of 2 to 3 years.
So, you know, I learned a lot of painful lessons in the 90s as fantastic years we have in our first five or six years as essential matters became a struggle and just the early 90s to mid 90s was the terrible time on the short side.
RITHOLTZ: I can imagine.
CHANOS: And just, you know, whether it was paying people out of my own pocket or having to really go and search hard for investors, it was a time we got through it and I got through it with great partners and great employees but you know, a little adversity sometimes is a good life lesson.
RITHOLTZ: That’s how you harden steel. Tell us what you do for fun what you do to relax when you’re out of the office?
CHANOS: So I travel a fair amount, I enjoy that, I read a fair amount and I do teach. I mean the teaching has been over the last eight years, I teach up at Yale at SOM and also about every other year at the University of Wisconsin which is my family alma mater, Wisconsin. And it’s been a lot of fun, it’s been enjoyable, I enjoy interacting with the students, it’s a fun course, we teach the starting in the 1690s all the way up to today and we teach about some of the great episodes of financial market fraud from the Mississippi scheme and South Sea bubble all the way to Donald Trump’s hotel and resorts and some of the more recent things and do so in a thematic and systematic way.
RITHOLTZ: So speaking of students and college grad student, if one of them or millennial came up to you and said I’m looking on some career guidance and I’m considering a job in finance, what sort of advice would you give them?
CHANOS: One of the things I tell my students and young people who come up to me to ask for that kind of advice is I sort of ask them, you know, are you — is this something you feel you want to do as a career in a big institution, do you want — do you feel you want to go out and do something on your own entrepreneurial, and if it’s the latter I try to impress upon them that unlike what they might consider conventional wisdom, I tell them that the time to take risks is when they’re youngest.
Yes, you need certain skills of course but it’s very, very hard, once you’re in your 40s and 50s and you got the obligations of life, financial, family, education, to then up and say I’m going to go do this on my own, and by the way if you do and it doesn’t work out, you kind of that’s it.
RITHOLTZ: You are done.
CHANOS: Right and on the other hand if you’re 25, 26 and you have a great idea and you have a backer, go for it, if you fail, nobody’s going to hold it against you. You were — in fact they might even admire you for it and so I always tell people if they are going to go do something with a small group of people, do it when you are youngest not when you’re — not when you’re 20 years or 30 years into it because you’re not going to be able to do it as easily then and if it fails and by the way most things do, you just dust yourself off and pick yourself up and dust yourself off and you know, go do something else. It’s not the end of the world for you.
RITHOLTZ: Very interesting, very interesting advice, our final question what is it that you know that shortselling today that you wish you knew 30 years ago when you first launched Kynicos?
CHANOS: Not to do it.
RITHOLTZ: Is that true?
CHANOS: No, but again my sense of timing wasn’t exactly fantastic, right? And so…
RITHOLTZ: You launched a short fund just as a 30 year bull market was going to…
CHANOS: Yes, pretty much, exactly, so again timing is not a forte.
Lots of lessons I’ve learned along the way on managing risk both on in a portfolio, career and sadly however in our business, you sort of have to learn them yourselves, it is hard to impart them, you can you can speak all you want but the market is a cruel mistress and she tends to impart her lessons on everyone singularly and individually.
RITHOLTZ: We have been speaking with Kynicos Associates’ Jim Chanos, if you enjoyed this conversation be sure to look up an inch or down an inch, you can see any of our other 200 or so conversations on Apple iTunes, Bloomberg, Overcast wherever your finer podcasts are sold.
Check out my daily column on BloombergView.com, you can follow me on Twitter @Ritholtz, I would be remiss if I did not thank our crack staff who helps put together these conversations. Medina Parwana is our producer/audio engineer, Taylor Riggs is our Booker, Mike Batnick is our head of research.
I’m Barry Ritholtz, you have been listening to Masters in Business on Bloomberg Radio.
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