The New Market Wizards: Conversations with America's Top Traders (25 page)

THE ART OF TOP-DOWN INVESTING

S
tanley Druckenmiller belongs to the rarefied world of managers who control multibillion-dollar portfolios. Achieving a near 40 percent return on a $100 million portfolio is impressive, but realizing that performance level on a multibillion-dollar fund is incredible. In the three years since he assumed active management control of the Quantum Fund from his mentor and idol, George Soros, Druckenmiller has realized an average annual return of over 38 percent on assets ranging between $2.0 billion and $3.5 billion.

Druckenmiller has been on a fast track ever since he decided to for-sake graduate school for the real world. After less than one year as a stock analyst for the Pittsburgh National Bank, Druckenmiller was promoted to the position of director of equity research. Druckenmiller dismisses his sudden promotion as the act of an eccentric, albeit brilliant, division manager. However, one suspects there was more to it, particularly in light of Druckenmiller’s subsequent achievements. Less than one year later, when the division head who had hired Druckenmiller left the bank, Druckenmiller was promoted to assume his slot, once again leapfrogging a host of senior managers maneuvering for the same position. Two years later, in 1980, at the young age of twenty-eight, Druckenmiller left the bank to launch his own money management firm, Duquesne Capital Management.

In 1986, Druckenmiller was recruited by Dreyfus as a fund manager. As part of the agreement, Dreyfus permitted Druckenmiller to continue managing his own Duquesne Fund. By the time Druckenmiller joined Dreyfus, his management style had been transformed from a conventional approach of holding a portfolio of stocks into an eclectic strategy incorporating bonds, currencies, and stocks, with the flexibility of trading any of these markets from both the short side and the long side. Dreyfus was so enamored with Druckenmiller’s innate market approach that the company developed a few funds around him, the most popular being the Strategic Aggressive Investing Fund, which was the best-performing fund in the industry from its date of inception (March 1987) until Druckenmiller left Dreyfus in August 1988.

Druckenmiller’s popularity at Dreyfus proved to be too much of a good thing. Eventually, he found himself managing seven funds at Dreyfus, in addition to his own Duquesne Fund. The strain of all this activity and his desire to work with Soros, who Druckenmiller considers the greatest investor of our time, prompted him to leave Dreyfus for Soros Management. Shortly thereafter, Soros turned over the management of his fund to Druckenmiller, as Soros left to pursue his goal of helping to transform the closed economies of Eastern Europe and the former Soviet Union.

The longest-running measure of Druckenmiller’s performance in the markets is his own Duquesne fund. Since its inception in 1980, the fund has averaged 37 percent annually. Druckenmiller stresses that the early years of Duquesne’s performance are not directly relevant since the fund’s structure changed completely in mid-1986 to accommodate the flexible trading approach he now uses. Measured from this later starting point, Druckenmiller’s average annual return has been 45 percent.

I interviewed Druckenmiller at his co-op apartment on a weekend day. I was surprised by his youth; I had hardly expected someone who had been managing one of the world’s largest funds for several years to still be in his thirties. As we relaxed in the living room, our conversation began with Druckenmiller’s story of how he got started in the business.

I had enrolled in graduate school to study for an economics degree. However, I found the program overly quantitative and theoretical, with little emphasis on real-life applications. I was very disappointed and dropped out in the second semester. I took a job as a management trainee at the Pittsburgh National Bank, with the idea that the program would provide me with a broad overview that would help me to decide on an area of focus.

I had been at the bank for several months when I received a call from the manager in the trust department. “I hear you attended the University of Michigan,” he said. When I confirmed his statement, he said, “Great.” He asked whether I had an M.B.A. I told him that I did not. He said, “That’s even better. Come on up; you’re hired.”

What job did he give you?

I was hired as a bank and chemical stock analyst.

Was that the type of position you perceived yourself heading toward?

I really had no idea what kind of job I would end up with. Most of the people who entered the management training program at the bank had an immediate goal of becoming a loan officer. I thought that I had been doing pretty well when the head of the loan department informed me that I would make a terrible loan officer. He said that I was too interested in the actual functioning of the companies, whereas a loan officer’s job was essentially a sales position. He thought my personality was too abrupt and generally unsuitable for sales. I remember feeling quite let down by being told that I was going to be a failure, when all along I had thought that I was doing quite well in the program.

Tell me about your early experiences as a stock analyst.

The director of investments was Speros Drelles, the person who had hired me. He was brilliant, with a great aptitude for teaching, but he was also quite eccentric. When I was twenty-five and had been in the department for only about a year, he summoned me into his office and announced that he was going to make me the director of equity research. This was quite a bizarre move, since my boss was about fifty years old and had been with the bank for over twenty-five years. Moreover, all the other analysts had M.B.A.’s and had been in the department longer than I had.

“You know why I’m doing this, don’t you?” he asked.

“No,” I replied.

“For the same reason they send eighteen-year-olds into war.”

“Why is that?” I asked.

“Because they’re too dumb to know not to charge.” Drelles continued, “The small cap [capitalization] stocks have been in a bear market for ten years [this conversation transpired in 1978], and I think there’s going to be a huge, liquidity-driven bull market sometime in the next decade. Frankly, I have a lot of scars from the past ten years, while you don’t. I think we’ll make a great team because you’ll be too stupid and inexperienced to know not to try to buy everything. That other guy out there,” he said, referring to my boss, the exiting director of equity research, “is just as stale as I am.”

So, essentially, you leapfrogged your boss. Was there any resentment?

Very much so, and it was quite unpleasant. Although I now realize that my boss handled himself very well given the circumstances. He was very bitter, but I certainly understand his sense of resentment much better now than I did then. I couldn’t envision myself responding any better twelve years from now if someone replaced me with a twenty-five-year-old.

Obviously, Drelles didn’t just make you head of research because of your youth. There must have been more to it.

I had a natural aptitude for the business, and I think he was impressed with the job I did analyzing the banking industry. For example, at the time, Citicorp was going crazy with international loans, and I had done a major bearish piece, which proved to be correct. Although I hadn’t taken a business course, I was fairly lucid in economics and probably made a good impression with my grasp of international money flows.

What was done with the research that you generated?

The analysts presented their ideas to a stock selection committee, which consisted of seven members. After the presentation, there was an intense question-and-answer period in which the analysts defended their recommendations.

What happened to the recommendations after the presentation?

If a majority of the committee approved the idea, it would be placed on the stock selection list. Once a stock was placed on the list, the portfolio managers at the bank were permitted to buy that stock. They were not allowed to purchase any stocks that were not on the list.

What happened if you were bearish on a stock?

If the recommendation was accepted, the stock would be deleted from the approved list.

Did you like being an analyst?

I loved it. I came in at six in the morning and stayed until eight at night. Remember, this was a bank, not a brokerage firm at which such hours represent normal behavior. Interestingly, even though Drelles had been at the bank for thirty years, he kept similar hours.

What kind of analytical approach did you use in evaluating stocks?

When I first started out, I did very thorough papers covering every aspect of a stock or industry. Before I could make the presentation to the stock selection committee, I first had to submit the paper to the research director. I particularly remember the time I gave him my paper on the banking industry. I felt very proud of my work. However, he read through it and said, “This is useless. What makes the stock go up and down?” That comment acted as a spur. Thereafter, I focused my analysis on seeking to identify the factors that were strongly correlated to a stock’s price movement as opposed to looking at all the fundamentals. Frankly, even today, many analysts still don’t know what makes their particular stocks go up and down.

What did you find was the answer?

Very often the key factor is related to earnings. This is particularly true of the bank stocks. Chemical stocks, however, behave quite differently. In this industry, the key factor seems to be capacity. The ideal time to buy the chemical stocks is after a lot of capacity has left the industry and there’s a catalyst that you believe will trigger an increase in demand. Conversely, the ideal time to sell these stocks is when there are lots of announcements for new plants, not when the earnings turn down. The reason for this behavioral pattern is that expansion plans mean that earnings will go down in two to three years, and the stock market tends to anticipate such developments.

Another discipline I learned that helped me determine whether a stock would go up or down is technical analysis. Drelles was very technically oriented, and I was probably more receptive to technical analysis than anyone else in the department. Even though Drelles was the boss, a lot of people thought he was a kook because of all the chart books he kept. However, I found that technical analysis could be very effective.

Did the rest of the analysts accept you as the research director, even though you were much younger and less experienced?

Once they realized that Drelles had made a decision and was going to stick with it, they accepted the situation. However, later that same year, Drelles left the bank, and I suddenly found myself unprotected. I was only twenty-five years old, while all the other department heads were in their forties and fifties. As soon as the news broke that Drelles was leaving, a power struggle ensued among the department heads vying for his position.

Every Monday morning, I and the other department heads would present our views to the head of the trust department, a lawyer without any investment background. It was understood that he would use these presentations as input in making an eventual decision on Drelles’s replacement. Clearly, everyone assumed that I was out of the running. The general belief was that I would be lucky to simply hold onto my job as research director, let alone inherit Drelles’s position.

As it turned out, shortly after Drelles left, the Shah of Iran was overthrown. Here’s where my inexperience really paid off. When the shah was deposed, I decided that we should put 70 percent of our money in oil stocks and the rest in defense stocks. This course of action seemed so logical to me that I didn’t consider doing anything else. At the time, I didn’t yet understand diversification. As research director, I had the authority to allow only those recommendations I favored to be presented to the stock selection committee, and I used this control to restrict the presentations largely to oil and defense stocks.

I presented the same strategy to the head of the trust department each Monday morning. Not surprisingly, the other department heads argued against my position just for the sake of taking the opposite view. They would try to put down anything I said. However, there are times in your career when everything that you do is right—and this was one of those times. Of course, now I would never even dream of putting 70 percent of a portfolio in oil stocks, but at the time I didn’t know better. Fortunately, it was the ideal position to have, and our stock selection list outperformed the S&P 500 by multiples. After about nine months, to everyone’s complete amazement, I was named to assume Drelles’s former position as the director of investments.

When did you leave the bank?

In 1980 I went to make a presentation in New York. After the talk, one of the audience members approached me and exclaimed, “You’re at a bank! What the hell are you doing at a bank?”