Lost Decade for Stocks? Not If You're Long-Short

9.9%. That's the total cumulative return of the S&P 500 from January 1999 to December 2009.

An investor who plunked down $10,000 in an S&P index fund in 1999 was sitting on just $10,990 eleven years later. That's a measly annualized return of 0.9%, far short of inflation, and worse than you would have gotten from just keeping your money stuffed in a savings account.

Let's call it what it is: 11 years of straight-up market misery. Kind of makes you think buy and hold really is dead after all.

Then there's this: 158.2%.

That's the net cumulative return of T2 Partners over the same period. That works out to 9% per year, turning $10,000 into $26,000.

You may think buy and hold is dead, but investing in T2 sure isn't!

T2 Partners? Who?
T2 Partners is a small fund run by Whitney Tilson and Glenn Tongue, hard-nosed value hunters with a proven knack for finding investment opportunities where very few are willing to tread. We're talking special situations, spinoffs, stock warrants, and even companies in bankruptcy.

Overall, T2's portfolio was up 31.9% in 2009, clobbering the market. And Tilson and gang are at it again in 2010. Through July, T2 is up 13.9% versus a flat S&P 500.

While those are very impressive performances, the one number that stands out to me is -18.1% -- as in, T2's 2008 performance.

Year

2006

2007

2008

2009

2010 Jan-Jul

T2

25.2%

(3.2%)

(18.1%)

31.9%

13.9%

S&P 500

15.8%

5.5%

(37%)

26.5%

(0.1%)

Why exactly am I impressed with an 18.1% loss? Well, just compare that to the S&P 500's performance in 2008. Most investors, including yours truly, got destroyed in 2008. We face an enormous climb to get back to even.

T2, on the other hand, emerged mostly unscathed. By midway through last year, T2 had already made back all of its losses from 2008. That kind of impressive capital preservation is the reason T2 is already on its way to making new highs, while most investors are still climbing out of a deep hole.

How'd they do it?
For T2, it's a simple formula. Tilson and team always keep at least 20% of T2's portfolio short. The fact that most stocks underperform a diversified index over time makes that a prudent strategy. But it also makes a lot of sense in times when even the best stocks take it on the chin. By betting against a slew of bad performers, T2 was able to stay afloat in 2008 when most portfolios and mutual funds sank to the bottom.

Here's a sample of stocks that T2 shorted in 2008: AIG, Ambac, Bear Stearns, Fannie Mae, Freddie Mac, Lehman Brothers, Moody's, Wachovia, and Washington Mutual. Most of these companies either went bankrupt, were sold to rivals for a fraction of their value, or ended up in some form of government conservatorship. Nice work T2!

But let's see what Tilson and team have been up to lately on the short side. Here are some of T2's recent short positions according to its past few investor letters and its most recent 13-F filing.

  • Barnes & Noble (NYSE: BKS  )
  • Boyd Gaming (NYSE: BYD  )
  • InterOil (NYSE: IOC  )
  • MBIA (NYSE: MBI  )
  • Netflix (Nasdaq: NFLX  )
  • VistaPrint (Nasdaq: VPRT  )

Now, the fact that T2 has been short these names in recent months doesn't make them no-brainer shorts, but there's still reason to question all of them.

Can brick-and-mortar Barnes & Noble survive, let alone compete against Amazon.com (Nasdaq: AMZN  ) ? Are investors too optimistic about InterOil's production potential? Can Netflix successfully transition from a DVD-by-mail business to the country's preeminent entertainment portal? A recent earnings miss sent VistaPrint tumbling down to earth -- can it grow profitably?

In addition, Boyd Gaming is suffering from many of the same issues as other casino businesses, and MBIA's survival could depend on numerous lawsuits related to its decision to insure billions worth of falsely rated mortgage-backed securities during the height of the housing bubble.

Investing the T2 way
Most of us are pretty anxious about the stock market right now. Do we go higher from here, or do we crash back to those ugly March 2009 lows? What if the next 10 years are just as bad for the stock market as the last 10? What does that mean for our financial futures, our standard of living, our retirement plans?

The great thing about the T2 long-short approach is that we don't necessarily have to worry about the general direction of the stock market. Just like Tilson and team, we can score big returns in any market, as long as we're willing to dedicate a good chunk of our portfolio to short positions.

If you're looking to short individual stocks for big gains. or to hedge long positions in your portfolio, enter your email in the box below. You'll get our latest ideas, plus two brand new reports, "5 Red Flags -- How to Find the BIG Short" and "4 Deadly Mistakes Even the Pros Make," free right now.

Matthew Argersinger doesn't own and isn't short any of the stocks mentioned. Moody's is a Motley Fool Inside Value recommendation. Vistaprint is a Motley Fool Rule Breakers selection. Amazon.com, Moody's, and Netflix are Motley Fool Stock Advisor picks. Motley Fool Options has recommended writing covered calls on Moody's. The Fool owns shares of Vistaprint. True to its name, The Motley Fool is made up of a motley assortment of writers and analysts, each with a unique perspective; sometimes we agree, sometimes we disagree, but we all believe in the power of learning from each other through our Foolish community. The Motley Fool has a disclosure policy.


Read/Post Comments (3) | Recommend This Article (18)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On September 10, 2010, at 11:26 AM, RobertC314 wrote:

    Interesting that Netflix made the list as it seems to be a perennial MF favorite. Anyone have any thoughts?

  • Report this Comment On September 12, 2010, at 8:50 AM, feldmail wrote:

    How is T2 able to short BKS? Recently, my broker's quote was over 20% for the hard-to-borrow fee. Over the last few months, it was in the 7 - 10% range. Couple that with the 25 cent quarterly dividend, you have a severe headwind on the short. Is T2 somehow borrowing this stock without paying the borrow fee or is my broker ripping me off?

  • Report this Comment On September 13, 2010, at 10:25 AM, TMFMattyA wrote:

    @feldmail, can't answer that of course. But hedge funds play by a different set of rules than us individual investors. It's possible they've got a special deal worked out with their prime broker that enables them to borrow the shares cheaply.

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