Kass: What to Do When the Smart Guys Lose

I am particularly struck by the recent series of high-profile investor blunders by the "smart guys" -- namely, large corporations, entrepreneurs (especially of a real estate kind) and savvy investment and hedge fund managers -- which are proof positive how difficult 2008 to 2009 might end up being for investors.

I am not even writing about the $500 billion-plus credit derivative disaster; I am writing about plain vanilla equity investing. Jim "El Capitan" Cramer wrote an interesting column on this subject late last week.

Consider the following errors by smart guys:

• In August 2007, Bank of America (BAC Quote) acquired a $2 billion minority stake in Countrywide Financial (CFC Quote) at $18 per share. The shares of Countrywide now trade at $8.
• In late November 2007, the Abu Dhabi Investment Authority acquired $7.5 billion of Citigroup (C Quote) stock convertible at $37 and higher. Citigroup's shares now trade at $28.
• During the course of the past six months, entrepreneur Joe Lewis has acquired nearly 10% of Bear Stearns (BSC Quote). It is not clear what his average cost is -- around $100 is a reasonable guess -- but he is believed to have a paper loss of at least $250 million. Bear Stearns shares now trade at $78.
• Real estate developer Harry Macklowe acquired a number of trophy midtown Manhattan office properties from Equity Office Properties at the height of the market's values and before the seizure in the credit markets. An inability of rolling over the debt could crush the Macklowe real estate empire.
• In May 2007, ESL's Ed Lampert announced that it acquired an initial stake worth about $800 million in Citigroup. At that time, the shares traded about $53. He is generally believed to have substantially added to his holdings in Citigroup since then. Again, Citigroup's shares now trade at $28.
• Pershing Square's William Ackman acquired 10% of Target (TGT Quote). Ackman first disclosed his position in July 2007, when the shares traded at about $65. Target's shares now are priced at $48. (CNBC's David Faber reported that Pershing's segregated fund committed to the Target investment experienced considerable losses over the last two months.)
• Former SEC commissioner and now hedge fund activist Richard Breeden has raised his stake in Zale (ZLC Quote) to almost 6 million shares -- he first filed with about 4 million shares in September 2007 -- or over 13% of outstanding common stock. SAC's Steve Cohen, the very best hedgie extant, also made a 13D filing back in September 2007. Back then, Zale shares traded in the mid-$20s; they closed at $13 on Friday.
• Less than one month ago, Warburg Pincus acquired $1 billion of MBIA (MBI Quote) at $31 per share. MBIA's shares have since taken a southerly route and now stand at $17.

The above list is not all-inclusive; there are many other examples of smart guys losing their shirts. These costly mistakes should be a sign for us mortals that the going is getting tough.

For these reasons and others, I have consistently offered some rare advice in 2007 that bears repeating for 2008: Keep investing/trading positions small, as volatility and disappointment will occur with greater regularity.

A more hostile economic environment, at best, will lead to substandard stock market returns; at worst, it will lead to large losses. As I have written over the last six months, the next shoe to drop could be disintermediation (outflows) and closures in the hedge fund industry.

The passing of a political era concurrent with an economic era holds great import for investors. Don't be caught in the past, which is no longer the prologue for the future.

The smart guys (politicians and investors) are losing big. Learn from their mistakes.