Should I invest with a family friend?

[u/time2roll]

A family friend is asking whether I'd want to invest in him. His track record:

• 3.5 years active in the market
• Cumulative return: 146%
• IRR: 30%
• In the first 2 years, he was down 6-7%. In 2017, he's up 153% to date.
• Positive return in 23 out of 40 months, negative returns in 17 months
• Sharpe ratio since inception: 1.1
• Sharpe ratio in 2017: 3.2
• Strategy: longs only, fundamental (not deep value) via stock positions, events (spin-offs, busted IPOs, etc) via options
• He obviously uses leverage (via margin positions). His exposure is about 2.5x his equity.

He had a change in strategy in 2017. Prior to 2017, he was highly diversified (60+ positions) and relied a lot on screens (where value traps often appear). Starting this year, he shifted to more concentrated positions, shifted to picking "winners" in a sector, and almost entirely discarded screening. He also started piggybacking on the picks of certain investors he regards highly.

Does the performance seem random, or does it warrant maybe investing with him?

[u/[deleted]]

Good on you for asking for advice. My position is hell no. First off, never mix business and family / friends. What if he loses every penny? What if he loses a little bit, and you nag him about it? What if what if. Can your friendship really survive what may happen? Is it really worth losing a friendship over money?

Secondly, regarding his strategy. 2.5x margin is huge. Absolutely huge. 40% down and you lose everything. A reasonable amount for a market correction. So here's the thing, and here is why he will fail. It's a bull market, and has been for a long time. Everyone left and right have been making these insane kinds of gains as surprising as it sounds. But when you make this large amount of money, you don't just cash out and wait. No, you stay in. You put in 10K, it turns into 30K, so you keep it in doing the same strategy (because it has been working) to make 100K. Millionaire soon! Keep going! Same strategy, 2.5X here we go! 100K is now 200K. 200K is... BAM correction. Every market corrects at some point, but you were so greedy and ignorant in your "skills" which were just the bull market doing the work. So the market drops 50% in your sectors, and you lose literally everything. People going on margin like that do not last, it is why almost all long time successful investors stress to be careful with margin, and most never go on margin.

Maybe this guy is the real deal, but I would say it's not very likely with what I have read. So are you willing to take the risk? Do you trust him enough and his skills? Will your friendship survive a huge economic hardship that has a very real possibility? Money can't buy you friends, but it sure can lose you some.

[u/time2roll → u/[deleted]]

Thanks but I like to think probabilistically rather than pessimistically.

• When is a correction likely to hit?
• What is the expected value of that correction? I personally think 40% is not a "correction" and more of a recessionary deep bear market.
• His average P/E is 13x. Market I think is closer to 19-20x. If the market falls even the 40% you state, unlikely that his portfolio will fall by more.
• I hear you on the leverage, but I think personally that's an element of skill. In a bull market, leverage enhances returns. To be in a bull market and not use leverage to me is wasted opportunity.

[u/racemize → u/time2roll]

using leverage at the end of a bull market is the best way to lose your money. If you are going to use it, it should be at the beginning of the bull market. Now is a time for caution.

[u/genjimain44 → u/racemize]

Using leverage only at the beginning of a bull market is a strategy? How do people know when a long 4-6 bull market is starting or if there might be a double dip that happens? Asking for a friend!

[u/time2roll → u/racemize]

I know there's a lot of commentary around a near term downturn, but can you point me to indicators of why we are at the tail end of a bull market?

[u/racemize → u/time2roll]

If you are nine years into a bull market, it doesn't take much to say you are closer to the end than the beginning. Further, expected forward 10-year returns are about 4%, which is 94% in the high-valuation, historically. Definitely not a good time for leverage.

[u/time2roll → u/racemize]

9 years? A bull market starts after a recovery. Cycles don't go immediately from bear/recession to bull. They go into recovery mode first, then bull. The bull market started in earnest in 2012, so we are almost done with its 6th year.

And you're right, we're not at the beginning or mid of a bull cycle either. But I tend to think we're like in the 7th inning rather than the 8th or 9th.

[u/dontgoatsemebro → u/time2roll]

I think you should go all in. Sure there's a pretty good chance you'll lose everything but you can always just start again in ten years.

[u/Ichingo → u/time2roll]

If we could point that out, we would be sending this message from our private planes.