Is Carl Icahn smart or dumb?

One of my investing idols, Howard Marks, regularly mentions something he learned as a college freshman back in 1963: you can’t judge the quality of a decision by its outcome. This seems very counterintuitive at first glance. But in the world of investing especially, it is spot on.

I’m sure you’ve heard the phrase, “Past performance is not a predictor of future results.” The question to ponder is why? Why can’t we just put all our money into the stock or mutual fund that was the best performer over the last year or decade? Why does this approach never consistently work and, more often than not, result in disastrous outcomes?

The answer is quite simple. In-fact, it can be summed-up in one-word…chance.

Chance, or randomness, is an omnipresent factor in all walks of life. It definitely keeps things interesting…for better or worse. It also makes the task of deciphering skill from luck in investing very difficult. The COVID-19 pandemic provides a great case-study illustrating why.

Is Carl Icahn smart or dumb?

Although he’s not publicly as well known as Warren Buffett, Carl Icahn surely sits in the pantheon of greatest investors of all time. For Icahn, 2020 has been a tale of two investments with wildly different outcomes that were driven by the same chance event.

Last year, Icahn disclosed he had made an investment that would pay-off in droves should a group of shopping malls default on their debts. The investment itself is complicated but it’s effectively the same strategy that a number of hedge funds employed in the 2006-2008 period when bets were made that paid off when homeowners defaulted on mortgages.

When the pandemic hit in March and many parts of the US economy closed, shopping malls were hit particularly hard. The malls Icahn bet against did in-fact start to default and although the official gains are unknown, it has been reported that Carl Icahn’s investment generated billions in profits.

However, Icahn had another investment with the opposite fate. Leading into the global pandemic, his firm owned nearly 40% of the outstanding stock of the car rental company Hertz. With travel virtually coming to a dead stop in March, Hertz was forced into bankruptcy and Icahn reportedly took a $2 billion loss.

So here’s the question: Is Carl Icahn an investing genius because a bunch of lower tier shopping malls defaulted on their debt, or stupid because Hertz filed for bankruptcy?

You probably saw this coming, but the answer is you can’t judge either of these investments solely by their outcome. The exact same chance event is ultimately responsible for what turned out to be a windfall on one, and a complete disaster on the other.

In either of Icahn’s two investments, it’s actually quite plausible that the opposite of both outcomes would have occurred had COVID-19 never hit. A number of hedge funds had made the same bet against shopping malls in recent years. It had not been a winning investment as the strong economy allowed many lower tier malls to hang on despite their challenges. In-fact, one hedge fund actually folded up last year as its big bet, which had been made in 2017, languished against a rallying stock market. Had the pandemic never emerged, the economic expansion very well could have continued for some time, perhaps years, and Icahn’s bet may have never played out. But at the same time, a strong economy and robust travel could have propelled Hertz into a very profitable investment.

The point is, in both of Icahn’s investments, the outcome was driven more by a chance event than any other factor. Therefore, even in hindsight the end result alone is not a good basis for judging whether either of these investment decisions was good or bad. 

This creates a problem for investors. If you can’t rely solely on outcomes (i.e. performance), how do you gauge whether your investments are well chosen or simply lucky? Unfortunately, the answer is far from perfect. Investments, like strategic business decisions or military operations, are made under great uncertainty. Therefore, they can only be assessed based on the logic used at the time with the known variables.

For example, if the current global pandemic is a once in a hundred-year event, can you really fault someone for opening a restaurant in January this year? The same could be said of Carl Icahn’s investment in Hertz. On the flip side, the way Icahn’s bet against shopping malls was structured, he could risk a relatively small amount of money for a massive gain should things play out as he envisioned. The plight of lower tier shopping centers across the US was well known. It was probably just a matter of time before a shock or economic slowdown resulted in increased defaults.  

The key difference between the investment in Hertz and the one against shopping malls is in the former, Icahn just got unlucky. In the latter, it’s hard to argue against his thesis that many malls were eventually doomed. He shrewdly established a position that would pay-off in droves should a disruption occur. In this case, it seems clear that the combination of sound logic and luck came together to produce a spectacular result.

Investment outcomes will always be significantly influenced by chance. Good ideas can end up failing and bad ideas can be rewarded. To be a successful investor, you must be able to distinguish between good (or bad) fortune and good (or bad) logic.