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To pay for his tuition, David Tepper was desperately looking for a way to make money. Competent in mathematics, Tepper knew he could become an exceptional trader. And soon enough, he found a profitable pattern. In the late '70s, options were relatively new. He found that certain option prices are always a bit slow to adjust to the change of their underlying securities.
Tepper sees this as a perfect opportunity for an arbitrage. With this pattern, he was able to generate consistent income to pay for all of his expenses in graduate school. Tepper started the firm 26 years ago and is said to have generated 25% annualized returns on average since then. Growing up in a poor family in Pittsburgh, Pennsylvania, Tepper always wanted to get rich, a better life.
He knew it wasn't going to be handed to him. He immersed himself in studying, hoping to finish in 3 years in college in order to save money and while also keeping a part-time job. Out of all the hedge fund billionaires, David Tepper really is the one that started from the bottom. Not only that, he suffered a lot of childhood trauma.
Despite these good things about my dad, he had a bad side, too. He was physically abusive to me. In our young life, there was nothing more terrifying. There was no greater adversity. But I prayed to God that I would never be the same to my children. After earning an MBA degree from Carnegie Mellon, David Tepper got a job in the Treasury Department at Ohio's Republic Steel.
But the company was in financial trouble. These guys are out of work. And why? That's the question. You said, "Why?" There, he was introduced to the junk bond market. In early '70s, investor Michael Milken put a wild theory into practice by pioneering a huge market for high-yield bonds, aka the junk bonds.
Tepper quickly realized he had a talent for trading junk bonds, which eventually helped him land a job at the infamous Goldman Sachs. He made a lot of money for Goldman Sachs, but in a bull market virtually everyone can do well. The real test is how well you can perform during a bear market. The law of gravity hit Wall Street today and financial markets around the world for that matter as stock prices plunged even more than they did on Black Tuesday of 1929.
During the market crash of 1987, virtually all traders lost money at Goldman Sachs, all but David Tepper. He saw the crash coming and set his entire portfolio as short. He made so much money by betting against everybody else. Goldman Sachs has a competitive culture. David Tepper was not well-liked at the firm.
But when I came up for partner, I got shot down. And I was incredibly upset. Finally, Tepper had enough. He started trading aggressively on his own account, preparing to make enough money to launch his own fund. Using his connections at Goldman Sachs, Tepper raised $57 million for his new hedge fund, Appaloosa.
Started my own company 25 years ago in 1993 called Appaloosa and ended up doing something that was a lot more fun and made my life better in so many ways. As soon as he started his fund, opportunity came knocking on the door. In the midst of Latin America crisis in early '90s, Tepper purchased many bank debts in Argentina right before the country started to recover.
As a result, the fund made 30% return in 1995. David Tepper is a different kind of value investor, so he's very much like Seth Klarman. If they find something that is undervalued, they will bet really big on it. Tepper kept making phenomenal returns during his early years until this happened. In 1998, the Central Bank of Russia defaulted on its debt, sending shockwaves to the world.
Like many investors at the time, Tepper put hundreds of millions of dollars in Russian bonds, thinking it was impossible for a country to default its debt. But he was wrong. When Russia government failed to pay their debt, Tepper lost $80 million. Then, Tepper did the unthinkable. He realized since the incident, the market has become overly pessimistic about Russian bonds, making them extremely undervalued.
He went long on the same bonds once again. By the end of 1990, he gained 61% as a result of his bets, recouping his previous losses and made much more. Distressed debt has become a goldmine for contrarian investors like Tepper. In 2001, Tepper generated 67% net return by focusing on distressed bonds.
But he would invest in anything he thought to be undervalued, either for short-term or for long-term. So, Appaloosa Management will do anything. He also has made huge profits year by year by investing in under the radar companies such as Myriad, an energy company. But none of it compared to the opportunity brought by the financial crisis of 2008.
likely the largest financial disaster in decades in this country and perhaps the Like everyone else, Tepper took a hit in 2008. His fund was down 28%. But he was enchanted because he saw so many undervalued opportunities. He knew his losses were just temporary. He was not going to let emotions dictate his trading.
If your thinking and your emotion is the same as everybody else's, then you cannot do the out thinking and what I call the second level thinking, which is required to act against the herd. The common word is contrarian. To sell at high prices, which are high because other people are optimistic and buy at low prices which are low because other people are depressed.
So Appaloosa quickly began buying all the common, preferred, and junior subordinated debt he could get his hands on, paying as little as 5 cents on the dollar for securities of AIG, Bank of America, and Citigroup. As predicted, his bets paid off. Bank of America got up more than 330% and Citigroup more than 220%, but the biggest prize was AIG.
He made a billion dollars from AIG alone. As humans, we suffer from various cognitive biases. People tend to find patterns that aren't there. With Robinhood, a lot of people are coming into this stock market casino. With David Tepper, it is possible that his success is due to luck, but there are two things that he does repeatedly that might be helpful for us to learn.
He always trades with a large margin of safety and uses no leverage. How much leverage? None. None? None. None. What do you need leverage for? When Washington Mutual was on the verge of bankruptcy, Tepper bought their debt at 50 and 60 cents on the dollar. Second, his strategy was more or less event-driven.
Not only did the asset have to be undervalued, David Tepper always tried to figure out why it is undervalued and what events that will happen in the future that will trigger value realization. Seth Klarman called these events the catalysts which trigger value realization. Started as a day trader in college with a dream of becoming rich, Tepper has come a long way building one of the most successful hedge funds in the world. Mhm.
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