This article is from Shaoshu Pai Investment.
When a financial crisis strikes, panic drives investors to flee, leaving behind a trail of devastation; yet this is precisely the time when deep-value investors look forward to the grand clearance sale of assets. The shelves are filled with an array of goods that dazzle the eye: stocks, bonds, companies, land plots, and more.
Some of these items are over-packaged, attempting to pass off inferior quality as superior; some are forced into liquidation due to dependency on others; others have only minor flaws but are disproportionately magnified by misinformation and misunderstood by the market.
Regardless of which category they fall into, the discounted goods often contain debts that erode their intrinsic value, albeit to varying degrees. The ability to discern the extent of this erosion depends on individual skill.
The financial world is not short of 'bargain-hunting' experts. Familiar names such as Soros, Howard Marks, and Seth Klarman stand out as top performers. They lie low during calm periods and seize opportunities before bubbles burst. Leveraging their exceptional valuation capabilities built on extensive research, they search for hidden gems in the rubble, uncovering value overlooked by others—what might be described as discovering 'neglected asymmetric returns.'
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On September 15, 2008, Lehman Brothers in the United States declared bankruptcy, marking the beginning of the subprime mortgage crisis that swept across America. In the following 15 months, the FDIC (Federal Deposit Insurance Corporation) took over 58 domestic banks, transforming itself into the largest asset recycler akin to a computer mall, amassing a vast inventory of various assets. These assets were categorized, reorganized, and repackaged to re-enter the market for auction.
Among these 'distressed assets,' some consisted of high-risk 'problematic loans,' while others were AAA-rated mortgage-backed securities with relatively lower default risks. Once restructured into asset packages by the FDIC, each package contained a mix of high- and low-quality assets, presenting differing risk profiles and price tags.
These asset packages appeared daily on the FDIC’s auction website, attracting greedy gazes akin to vultures. To the FDIC, everything was part of the non-performing assets requiring disposal, but in the eyes of some 'bottom-fishing' experts, every package held profit potential. The key factor, as always, was price.
Subsequent analysis by certain institutions revealed that the top bidder in this concentrated auction spree was BEAL BANK, a small bank from Texas. This bank belongs to the BEAL Financial Group established by Andrew Beal. By the end of 2000, its five-year return on equity exceeded 50%, making it one of the most profitable commercial banks in the U.S. By the end of 2010, its annual return on equity reached an impressive 27.5%, far surpassing the average profitability of the U.S. banking sector. More astonishingly, since its inception, the bank has never engaged in loan business. Approximately 20% of its entire asset base consists of distressed assets acquired through 'treasure hunting' in the market.
Under the same regulatory framework as the FDIC, this bank is eligible to offer deposit services to the general public. By offering interest rates nearly five times higher than the benchmark rate, it attracted substantial volumes of large-denomination certificates of deposit exceeding one year. Of course, given the near-zero benchmark interest rate environment prevailing in the U.S. banking industry, BEAL BANK effectively secured sufficient investable funds at a cost of less than 1%.
Based on this, under the astute guidance of Andrew Beal, the bank frequently took action during market downturns. In June 2000, when the failure of California’s electricity market triggered the California energy crisis, the bank acquired a large number of energy and infrastructure-related assets and bonds. In December 2001, following Enron's bankruptcy filing, they aggressively purchased energy-related assets from the market. After the September 11 attacks, amid nationwide panic, the bank decisively moved again to accumulate a significant amount of asset-backed securities in the shipping industry. Over the subsequent years, the bank gradually divested these assets, reaping enormous profits.
Between 2004 and 2007, the entire U.S. banking industry enjoyed the benefits of a credit boom, expanding their scale significantly. However, under Andrew Beal's leadership, BEAL BANK continuously sold off assets and reduced expenditures, shrinking its total asset size to 60% of its peak level. By 2008, when the bubble burst, BEAL BANK once again acted against the trend, spending $1.8 billion to become the biggest winner at an auction hosted by the FDIC. Additionally, it invested $500 million to acquire LyondellBasell Industries, a Fortune 500 chemical company, and later spent $600 million purchasing Trump's casinos. This series of aggressive acquisitions continued until 2010, when central banks around the world began implementing quantitative easing policies, prompting Andrew Beal to sense impending risks once more.
In behavioral finance, there is a representative term called 'selection bias,' which refers to people often estimating the probability of certain events based on their stereotypical views of specific occurrences, placing excessive emphasis on recent data changes while ignoring overall characteristics. Daniel Kahneman pointed out that due to the limitations of cognitive capacity, investors cannot process all information at a given time; individuals always select a few items as objects of cognition, making those recognized objects appear to stand out from the environment.
Therefore, whenever an economic downturn begins, people’s overly anxious emotions are released prematurely, causing risk appetite to plummet at a cliff-like rate. At this point, it represents the concentrated manifestation of 'selection bias': everyone starts tightening their belts to brace for a possible harsh winter ahead.
However, reality often moves in the opposite direction of what most expect. In Andrew Beal’s eyes, the onset of an economic recession marks the beginning of his bank’s offensive actions. He said, 'I search through junkyards filled with garbage, finding joy in discovering surprises. All of this stems from others’ misjudgment of the situation—they paid the price, and I gained the premium.'
Coincidentally, during the California energy crisis, another individual seized the opportunity alongside Andrew Beal to buy low. Amidst market stagnation, he substantially increased his holdings of nearly bankrupt Pacific Gas and Electric Company and Southern California Edison stocks. Subsequently, with government support, both companies improved their operations, and their stock prices more than doubled. This person was David Tepper, known on Wall Street as the 'bottom-fishing king.'
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David Tepper also had a penchant for 'bottom-fishing' unpopular assets. In 1997, during the Asian financial crisis, the Korean won depreciated sharply. Tepper bottom-fished Korean won futures and South Korean government bonds, earning a 29% return. In 1998, following Russia's sovereign debt default, Tepper, undeterred by short-term volatility, continuously increased his holdings of Russian government bonds. Amid controversy, he turned a profit after holding them for a year, accumulating a 60% gain. In 2009, Tepper made a contrarian heavy investment in Bank of America shares, generating $7 billion for his Appaloosa Management firm.
In terms of form and logic, David Tepper’s and Andrew Beal’s investment methods were similar—both consistently engaged in 'picking up trash' and focused exclusively on it. Tepper once said, 'We stay calm when others lose control. The key is that markets adapt, people adapt, and you should ignore all the nonsense circulating outside.'
Why do they always succeed in 'finding bargains'? Is it because of good luck, sharp insight, or the notion that the timid starve while the bold thrive? If it were luck, why does fortune favor only a select few? If it were about boldness, many macro hedge funds dare to bet against national fortunes, sifting through trash for scraps, yet they wouldn’t deign to associate with such behavior.
The real reason lies in the fact that most people focus on the 'garbage' or the error itself, whereas excellent investors or managers always concentrate on the underlying reasons behind the 'garbage' or errors—namely, human nature. Fully understanding the extremes of pessimism and optimism in human nature; deeply recognizing the tendency to underestimate difficulties and overestimate one’s ability to overcome them; carefully studying irrational behaviors among traders, patiently waiting for the majority to make mistakes—opportunities for 'bottom-fishing' naturally arise.
Therefore, whenever the darkest moments arrive, outstanding investors and managers will take a long-term development perspective, considering the long-term investment experience. Through in-depth research, they uncover returns overlooked by the majority in the market, refrain from blindly chasing trends, and calmly seek opportunities in others' pricing errors and misjudgments of expectations, finding valuable investments amidst so-called 'junk'.
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Editor/KOKO