day one would be worth now)
David Tepper has carried a chip on his shoulder since his childhood in a lower-middle-class neighborhood in Pittsburgh, where his local football team’s season was canceled for two straight years because there were too many fights. The son of an accountant father and a teacher mother, Tepper earned an economics degree far outside the Ivy League, at the University of Pittsburgh, and found his first job as a credit and securities analyst in the trust department of Pittsburgh-based Equibank. Although he eventually wound up at prestigious Goldman, Sachs & Co., he felt compelled to leave in 1992 after being turned down three times for partner. He lacked the connections of many of his colleagues, who were able to raise decent sums when they left Goldman to start their own hedge funds. Today, Tepper does not hide his satisfaction that 20 years after founding his Short Hills, New Jersey–based hedge fund firm, Appaloosa Management, he has posted a net annualized return of 28.44 percent, arguably the best record among non–quantitatively driven managers. He is also proud that in the most recent five-year period, Appaloosa’s net return was even higher — 30.54 percent — defying the conventional wisdom that most managers enjoy their best years when their funds are still small. Along the way, he has pulled off a seemingly impossible feat in the hedge fund industry: Whenever he has a losing year, investors beat a path to his door to get in. That’s because for each of the three years in which Appaloosa endured more than a 25 percent loss, Tepper followed with eye-popping gains, including triple-digit returns in two of those three years. This was especially impressive in 2009, when Tepper — an eclectic investor who gravitates to whatever markets he thinks offer the best opportunities at a given time — posted a 132 percent net gain, his second-best year. He achieved this in large part because he had the conviction and insight to buy beaten-down bank stocks after the U.S. government announced a plan to shore up bank capital and identified on the Treasury Department’s website a minimum price at which it would buy back the shares.
Alpha: How did you identify the bank play in 2009?
Tepper: We were looking at the banks on the downside. We already had positions on the short side. We knew the banks pretty well. We knew the laws, the different layers of the bank structure. So when the Treasury came out with their white paper, we knew it would be a securities law violation if they didn’t do what they said in print. The [banks] were really cheap at the time. We actually bought the hybrid bond preferreds and some equities. We exchanged preferred for common for Citigroup and Bank of America. We were one of the biggest holders of this paper next to the government.
How comfortable were you being the first into the investment?
That is nothing new for us. We are pretty comfortable given our analysis and the unanimity in our shop. We have lots of credit people; [we do lots of] analysis; we know the law. Everything is not without risks. When you go into markets to be first, you have to be willing to not catch the bottom. You may lose more money. I didn’t want to sue the U.S. government for misleading investors. But they put it in writing. They were subject to market regulation.
Did you have other big winners during the financial crisis?
We also made a lot of money on AIG. About one week before everyone thought they were going bankrupt, we bought $100 million of their commercial paper for 30 cents on the dollar. When they didn’t go bankrupt, the paper was worth par. But we figured even if AIG did go bankrupt, it was not a bad price to pay. We were lucky, but I would rather be lucky than be smart. But you have to be smart enough to put yourself in a position to be lucky. Appaloosa does that again and again.
How has your investment approach evolved?
We’re always looking for some inefficiency determined by the market. When we first started, we made a big bet in something called Algoma preferred. It was a steel company coming out of bankruptcy, trading at 27 cents on the dollar. But it wasn’t a preferred; it was a first mortgage bond. But the market didn’t understand that.
People say you have more nerve than any other investor because you are frequently first into an investment or trend.
You have to be unemotional and do the hard analysis, then have deep conviction.
You hate being called a big risk-taker, though.
Does being a risk-taker mean not being afraid of losing money sometimes? Then I’m a big risk-taker. Does it mean putting the firm in jeopardy? Then in that case I am not a big risk-taker. People have to understand, you can lose money because you take the right risks, not because you take the wrong risks — it just might take a little longer for certain risks to pay off. You don’t want to take too much risk. It’s okay to lose money. It is not a bad thing in the short term. But we don’t ever want to jeopardize the firm. Nobody has been down and come back like Appaloosa in the history of hedge funds.
No one gets to see another day after being down 25 percent three times. Why you?
Each time within six months we made back our high-water mark. No investors even left the second time. By the third time people wanted to come in. I guess you would call it a great business model.
Why have the recent years been so good for you?
The recent removal of many brokerage firms from risk-taking has made it easier in some ways to make money. Take some recent key event days. Instead of 20 different people inside those firms taking a position in the past, you now have maybe ten firms. So now you have more time to get into a position.
Besides the banks, what was your best trade over the years?
In 2002, 2003 after Enron collapsed, we bought bonds of [energy companies] Williams and El Paso for 20 cents on the dollar. We also bought the bonds of Marconi [a troubled U.K. telecommunications equipment maker] and [insurer] Conseco. When the shit hits the fan, no one does it better with distressed. But you need to get yourself unlevered. When we have our big years, we do it unlevered.
Also, after we lost a lot of money on Russian bonds in 1998, we bought Russian bonds again and Eurobonds. No bank wanted them on their balance sheet. We paid 16 cents on the dollar for Russian bonds of ’28, with a 12¾ percent coupon. We sold them for around 40 cents on the dollar. For us the themes are always the same: Do the analysis, and don’t be afraid to lose some money. The key is, you can lose money. Don’t lose your firm.
You started 2011 still heavily invested in the banks. However, you were only down about 3 percent. How did you avoid getting hurt as much as others were?
That may have been our best trading year. The dirty secret of Appaloosa is, we have been really good macro players for the past five years. We went long bonds, shorted stocks, bought put options. We sold the banks and bought them back later. We didn’t sit on the book. We would rather have a distressed cycle. It’s our bread and butter. But we are pretty good figuring how markets will run.
You seem to enjoy playing the hardscrabble guy from a working-class neighborhood who didn’t go to an Ivy League school.
You want me to say there is a chip somewhere? Yes. I paid my way through school. Leaving Goldman was a scary proposition. They didn’t give me my record. I didn’t raise $50 million because I had connections. I was from the inner city of Pittsburgh. I didn’t have any social contacts. The only thing I had was me.
How did your background shape you as an investor over the years?
Despite my confidence, I still have humility. I know the market is still smarter than I am. I always felt I’m not a fancy guy. I am not worried about losing my money — I’m worried about losing my investors’ money.
What is the biggest lesson you have learned?
The first lesson: Get your book down. People take advantage of you when you have too much leverage. With [auto-parts supplier] Delphi we learned a lesson about bankruptcy court — it is a court of equities, not a court of law.
Do you have a succession plan?
I’m not looking to have a business to sell.
Can Appaloosa remain intact whenever you decide to retire?
You can have a fund in Appaloosa [without me]. But it can’t be that big. I can imagine a smaller fund. Would it be the same? No. Something good? Absolutely.
What do you want your legacy to be?
I hope it is recognized that in the past 20 years I arguably have the best record and therefore may be the best of this generation.
— Interview by Stephen Taub