Show Me Your Hand – Betting on the Smart Money

Last summer David Einhorn won $659,730 for placing 18th in the World Series of Poker. Thats a pretty nice take for most people, but Einhorn isn’t most people. The 37-year old fund manager donated all of the proceeds to the Michael J. Fox Foundation for Parkinson’s Research. Placing 18th out of over 8,000 entrants is an amazing accomplishment, but so is beating the financial markets with a 25%+ return for the previous decade.

Einhorn started his hedge fund, Greenlight Capital, in 1995 after getting rejected from every Ph.D. program to which he applied. That $1M starting stake has since grown to over $4 billion.

In poker, it would be a huge advantage to know what cards the other players are holding. Being privy to what the best hedge funds on the Street hold would be a major advantage as well. By taking a dive into the SEC Edgar database and 13F filings, and investor can do just that.

Below we take a look at Greenlight’s holdings since 2000 via the 13F forms in a method similar to the Buffett study. The only variant is that this time we only take the top 10 holdings by size in the portfolio (to make it more manageable to track for the investor). Again, it includes all stocks that are no longer listed due to delistings, buyouts, mergers, bankruptcies, etc.

Many people would argue that I am simply taking advantage of the crystal ball effect (I know that Greenlight has done well in the past). True, but I would much rather have Einhorn picking my stocks (or Johnny Chan playing my cards) than your average mutual fund manager that can’t even beat his benchmark.

Some would also argue that the good returns are behind him, and that the size of his fund is restrictive. To that I say take a quick peek at what Citadel and SAC did in returns in 2006, both of which are > $10B in assets (Hint: Its over 30%).

(Note: We included all stocks no longer listed. While most people believe that including the stocks will increase results (takeovers, etc), in our two examples below they REDUCED results by ~400 bps. . . )

RESULTS FOR GREENLIGHT AND EMINENCE

The results were very strong, and will differ from those achieved by Greenlight for a whole host of reasons. Since this portfolio is long-only, the returns should be more volatile than his long-short fund. (One could also run this or any portfolio long with index or option hedges). Regardless, the results are below with ~30% annual returns, 30% volatility, and a Sharpe of around .95. If you then subtract the 2% management fee and 20% performance fee, you get pretty close to the 25% return reported in the general media for GL.