By Jonathan Yates
Counterpunching is the key to success for legendary investor Paul Tudor Jones II, founder of the hedge funds group, Tudor Investment Corporation.
A former welterweight boxing champion in college at the University of Virginia, like any seasoned master of the sweet science, the investment focus of Jones and his funds at Tudor Investment Corporation reflect that there are no big early wins with something as formidable as the financial markets; rather that success emanates from dominating the middle of the ring through macro trading, controlling the corners and developing your best combination of moves to be deployed when the opportunity presents itself from event driven strategies.
In an interview, Jones likened this to playing three dimensional chess, whereas micro trading of one instrument would be chess on one plane. “When trading macro, you never have a complete information set or information edge the way analysts can have when trading individual securities. It’s a helluva lot easier to get an information edge on one stock than it is on the S&P 500,” he observed.
Jones furthered, “When it comes to trading macro, you cannot rely solely on the fundamentals; you have to be a tape reader, which is something of a lost art form. The inability to read a tape and spot trends is also why so many in the relative value space who rely solely on fundamentals have been annihilated in the past decade. Markets have consistently experienced ‘100 year events’ every five years.”
Such an event appeared for Jones in 1987, when he predicted “Black Monday,” tripling his money through short positions when the New York Stock Exchange shed 500 points from the Dow Jones Average on October 19. At the closing bell that afternoon, the Dow was wobbling at 1738.74, a plunge of 22.61 percent (the largest one day drop, except for periods of market closure such as after September 11, 2011). It is estimated that Paul Tudor Jones made about $100 million that day.
Waiting for these opportunities to emerge, Jones invests to control the middle through swing trading. This allows him to limit the exposure of his capital, yet benefit when the financial markets begin to move from external events. Here he invests defensively, trading the smallest amount when the market is the least opportune. To further limit losses and control his trading, he never “averages down,” increasing a position to reduce the price per unit. By decreasing a losing position rather than increasing it through averaging down, his vulnerability to a reversal is never extended. His investment philosophy here is to play great defense, not great offense. For this, he deploys both price stops and time stops.
When the fundamentals turn is when Tudor Jones moves into position, by controlling the corners of the market through very low risk movements, never overexposing his position in the process. When a trade proves to be a winner, it is increased. When a price or time stop is reached, it is closed out, no matter what. Again: offense wins games, defense wins championships.
The recent portfolio of Tudor Jones Group evinces this approach. Most of the stocks added, were large caps (328 in all). These included Cisco, AT&T, Citi, Microsoft, Apache Corporation, Starwood Property Trust, Noble Energy and Peabody Energy. At over seven percent of the portfolio was the SPDR S&P 500 ETF Trust, the ultimate holding for a macro trader waiting for an opportunity from a turn in the market.
This portfolio is one crafted to react (100 year events happening every 5) in a volatile period of little, if any growth. “I think we’re going into one of those slow or no growth periods in the U.S., which will give us a lot of volatility,” remarked Jones. For this, deeply liquid holdings, such as SPDRs and Microsoft, are imperative. Stocks such as these, blue chips that will maintain value in a little or now growth epoch, pay dividends and allow for massive amounts of capital to be redeployed when an event inevitably arises.
If this period of little or no growth does evolve, as predicted by Tudor Jones, it will not be his first. He started work in the securities industry as a broker for EF Hutton in the late 1970s. From the late 1950s to the early 1980s, the Dow Jones Average was basically flat: it hit a high of 731 for the decade of the ‘50s in 1958 and was still trading in the 700s in the early 1980s. The high for the period of the ‘50s to the early 1980s was 1067, reached on January 11, 1973, before the first Arab oil embargo in October of that year. As a result of the first energy crisis, when OPEC nations quadrupled the price of oil overnight and eventually cut off supplies to the United States in retaliation for the U.S. support of Israel in the October 1973 Yom Kippur War, the Dow Jones Industrial Average hit a low of 570 on December 8, 1974, a plunge of 54.3 percent (adjusted for inflation).
During this span, Jones set up shop in Greenwich, Connecticut with Tudor Investment Corporation in 1980. Profitable from the beginning, he shunned Harvard Business School, as he realized his skill set was something that could not be taught or learned within the confines of ivy covered walls.
He attributes this period, the 1970s, with having the biggest impact on his career. “Trading commodity markets back in the late 1970s, when they were still extraordinarily volatile, allowed me to experience repeated bull and bear markets across a variety of different instruments,” he remembers. Not all of the memories from this time are pleasant, though. He furthered, “Remember, in agricultural markets the cycle the can be just 12 months. I lost my stake a couple of times, which taught me risk control and risk management.”
If the market for the period ahead will be little or no growth, there will be several factors favoring Tudor Investment Corporation. First will be its size. In the past decade, it has had close to $20 billion under management. As Marshal Zhukov, the Russian military strategist from World War II and mastermind of The Battle of Stalingrad noted, “Quantity has a quality all of its own.” Just the sheer mass of funds available to Tudor Investment Corporation will allow it to capitalize on events from which others will be precluded from moving forward due to a basic lack of liquidity.
There is also the fee structure. While the industry standard for hedge funds is two percent per annum of assets under management and twenty percent of profits, Tudor Investment Corporation charges four percent per annum for investing funds and takes twenty three percent of the profits for the house. Clients willing to pay a higher tariff obviously are demonstrating a greater commitment, meaning they will not withdraw their funds in inevitable periods when returns are low (and also resulting in a net worth over $3 billion for Jones, according to Forbes). This will prevent Tudor Investment Corporation from being sucked into the vortex of a death spiral that claimed so many hedge funds during The Great Recession.
Most importantly, is that Paul Tudor Jones, and Tudor Investment Corporation, is preparing for little or no growth, and maximum volatility. Volatility is a trader’s greatest ally and source of largest profits…when the holdings and investment professionals are primed for that eventuality. The composition of the portfolio as structured by Paul Tudor Jones reflects that belief. As a result, Tudor Investment Corporation is “locked and loaded,’ and the powder dry for whatever opportunities come into range and are targeted in the trading days ahead.