It’s a sweltering, 95-degree August day in Manhattan, but Jim Chanos — fresh off a two-week holiday, rocking a sharkskin suit — is pumped: Elon Musk had once again called a hero of the Thai cave rescue a pedophile.
It’s 1:30 in the afternoon. Chanos bolts through the door to his office building on West 55th Street, grabs the journalist waiting for him, and, on the elevator ride to his eighth-floor office, fills her in on the latest news.
“Musk is at it again. He’s doubling down on his pedophile comment,” Chanos says, amusement noticeable in his voice. Minutes earlier the CEO of Tesla Motors — who is already under investigation by the Securities and Exchange Commission for a tweet about taking the company private — had returned to an earlier tweetstorm in which he accused the British cave diver of being a “pedo guy”.
“You don’t think it’s strange he hasn’t sued me?” Musk tweeted at 12:30 p.m. on August 28. Tesla shares immediately began to slide, and within hours the diver’s lawyer reportedly informed Musk that he would, indeed, be sued.
Recent months have seen one bizarre event after another in the saga of the electric-automaker and its iconic boss, and Chanos has been watching it all. The 61-year-old founder of hedge fund Kynikos Associates announced his short against Tesla in the fall of 2015 and has been nursing losses ever since — for despite a raft of bad news and the increasingly controversial, and potentially illegal, behavior of Musk, Tesla’s stock, while off significantly from its highs, has stubbornly refused to crash.
The Tesla short made for a tense working vacation for Chanos, who had left New York for his annual trek to the Greek island of Mykonos on August 9. That was just two days after Musk tweeted that he was considering taking Tesla private — with the now-infamous “funding secured” line — and Wall Street went into a frenzy trying to see if it could happen.
Chanos was skeptical.
“I thought immediately it was not true, because I know Elon Musk at this point,” he said during a two-hour interview that touched on everything from hedge funds and short-selling to politics and the history of fraud, then, eventually, got back to social media and Musk. “The way it came out during market hours, right after the Saudi passive investment announcement [the Saudi sovereign wealth fund has reportedly taken a 5 percent stake in Tesla] — it was so irresponsible, number one, and was not clearly vetted, because no one who vetted that would’ve let him put that out.”
Although Kynikos’s two senior portfolio partners, Chuck Hobbs and David Glaymon, were monitoring the stock from New York, Chanos couldn’t stay away from the news, even in Mykonos. “It was breaking so fast,” Chanos says. As the stock rallied, he sold more shares short.
Finally, at 11:00 p.m. on Friday, August 24, Musk ended the suspense with a statement on Tesla’s blog. He had decided against going private.
Tesla has been the biggest short in the market for much of this past year, with nearly $10 billion wagered that its stock will fall. Chanos is hardly the only one who takes that view. Kynikos now runs less than $2 billion, and with individual short positions capped at 5 percent each for risk management purposes, Tesla represents at most about $100 million of the firm’s total short bets, which it currently has on 65 companies.
Win or lose, the Tesla short won’t make much of a difference to Kynikos’s bottom line. But for Chanos — who claims he’s also advising much larger “pools of capital” on their Tesla shorts — there’s more than money at stake.
Kynikos is the lone short-selling hedge fund of any size — and the only one that that has been in business since 1985.
That’s no mean feat, as the stock market has risen almost 1,500 percent since Kynikos’s debut. Chanos has lived through at least three bear markets — the 1987 crash, the bursting of the dot-com bubble in 2000, and the global financial crisis of 2008 — and he’s waiting patiently for the next one.
“I’m not saying it’s the top of the market, but on the other hand, bear markets haven’t been outlawed,” he quips.
Chanos, of course, is already a legend. He will go down in Wall Street history for predicting the demise of Enron Corp., whose collapse resulted in a wave of prosecutions and the imprisonment of top executives — the kind of harsh penalties that have not been seen since.
But that was in 2001 — 17 years ago.
Since the financial crisis year of 2008, Kynikos’s shorts overall have been bleeding red ink, and investors have bailed. Kynikos has lost almost three quarters of its assets since the end of 2008. This year alone, its funds had fallen between 9 percent and 19 percent through July (net of fees), depending on the fund, according to a report to investors Institutional Investor has seen that has not been previously reported on.
“It has been one giant short-squeeze market,” he moans.
Take Tesla. To Chanos it represents a market euphoria last witnessed during the dot-com craze. Although Tesla is unprofitable and loaded with debt, its market cap rivals that of General Motors. A rush to meet production targets on its midprice Model 3 sedan this year has been accompanied by defective cars, unhappy employees-turned-whistleblowers, and a stream of exiting executives — not to mention ever-stranger outbursts by a CEO under enormous pressure to meet the projections he promised shareholders. The current stock price of about $299 per share (above Chanos’s average cost of $250) is based on ambitious plans for the future. But what most people are missing, says Chanos, is that Tesla has quit making the capital investments required to realize those ambitions. It can no longer afford to do so.
But facts don’t seem to matter. As Chanos reminds us, referring to President Trump and his supporters, we are living in “a post-truth environment.” That translates, he argues, into a mood in which investors are also willing to suspend disbelief.
“If we don’t hold our leaders to that standard,” muses Chanos, “then why should we hold managements to that standard? I think that’s part of where we are now.”
Chanos, who jokes that he is considered an anarchist on Wall Street for his liberal political views, is not prone to proselytizing. He doesn’t write letters to the Securities and Exchange Commission or publish long treatises on his short theses. Though he believes the political environment has an impact on the market, he never counts on the SEC to take down the bad guys. “They’re archaeologists, not detectives,” he scoffs.
Chanos can appear world-weary and somewhat guarded — but, as the saying goes, in every cynic beats the bleeding heart of an idealist. “There’s more than a little of the crusader in him,” says longtime friend Jim Grant, founder and editor of Grant’s Interest Rate Observer. “He would like to clean up Wall Street. He would like to improve the quality of corporate reporting. He would like to rid Wall Street of the scoundrels and clean up corporate management.”
That might explain what happened earlier this summer.
On June 21, after a nearly six-month absence, the Twitter handle of @WallStCynic suddenly came back to life.
“I leave you all for six months, and look what happens,” the anonymous person tweeted.
At the end of December, that same individual, who calls himself Diogenes, had said he was exiting Twitter for one reason: “Dear FinTwit: It is with a heavy heart that I must leave Twitter to return to Ancient Greece on December 31. The SEC, beginning in 2018, is requiring registered investment advisors to disclose any social media anonymous accounts, on Form ADV.” The SEC, according to hedge fund attorneys, considers social media a form of marketing. If hedge fund moguls want to talk their book, they must disclose it.
In the world of financial Twitter, it is an open secret that the person behind Diogenes — the name of the leader of the Greek philosophical movement known as the Cynics — is Chanos, a third-generation Greek-American who likewise named his firm Kynikos, after the Greek word for “cynic.” His Twitter alter ego says he’s “searching for honesty on the Street.”
Chanos’s return to Twitter occurred three days after Tesla’s stock, which had dipped below $250 earlier in the year, jumped back up to $370, coming close to the high of $389 it reached in the summer of 2017. Chanos declined to discuss the Twitter handle; however, Kynikos is expected to formally disclose the account in its next annual ADV, which will be filed next March.
Since June, Diogenes has tweeted about Tesla and Musk on an almost daily basis, and sometimes even more frequently. Though anonymous, Diogenes’s comments, like Chanos himself, are more measured than those of many of Tesla’s other antagonists — and also show off his sardonic sense of humor.
“Again, please don’t park your Model 3 in the sun or rain, adjust the windows or wipers, or leave your car when parked,” Diogenes tweeted on August 29, referring to the multiple problems being reported with Tesla’s newest car.
Chanos, who is not shy about pushing his views in the media, knows that Twitter is the go-to medium for the Tesla story — for bears like him as well as for Musk. “This is the first instance where I think we are seeing a possible fraud unspool itself in real time, with social media commentary,” he says.
Tesla also offers an education about the state of today’s financial markets, says Chanos, who as a side gig teaches a course on the history of financial markets fraud at the Yale School of Management.
“Crazy companies are trading at really crazy valuations now, on top of their bad businesses. That’s kind of exciting. Tesla — I mean that’s some monster valuation for a company that might be bankrupt.”
It’s all part of what Chanos calls the fraud part of the cycle.
“There’s a very clear link between great episodes of fraud and the financial cycle. When we’ve had great frauds, they’ve always been at the tail end of great financial cycles,” says Chanos, putting on his professor’s hat as the interview continued in the Kynikos conference room, where one wall is lined with books on markets and finance, propped up by ceramic black-bear bookends.
“Inexorably, as the cycle goes on and you see your neighbors getting rich . . . suddenly you start to do things that you wouldn’t have done five or eight years earlier. And because the ultimate reinforcement for most people is price action . . . the more it goes up, the more [they] believe it must be okay. So it’s then easier for fraudsters to raise money, and generally they’re not exposed until the cycle turns down because then people stop funding them and want their money back,” he explains.
“A lot of frauds are in effect Ponzi schemes. And so when they can’t raise more and more capital, they collapse,” he adds.
Chanos thinks a wave of frauds is still ahead — and suspects Silicon Valley will be the locus of much of it. “We’re going to say, ‘How did we believe that?’ ” he says, then launches into a recommendation of Bad Blood: Secrets and Lies in a Silicon Valley Startup by Wall Street Journal reporter John Carreyrou, who uncovered the alleged fraud perpetrated by Elizabeth Holmes at Theranos, the Silicon Valley start-up whose revolutionary blood-testing technology turned out to be bogus.
“You’ve got to read it,” he insists. “There’s a subtheme — which gets back to Tesla —that there is a feeling in Silicon Valley that you can say anything you want to investors as long as you think you’re changing the world.”
Few people want to hear that kind of pessimism during boom times. And that’s a problem Chanos has encountered when marketing his hedge fund: He pitches it as insurance against a market downturn, but people don’t want to pay for insurance these days.
“We do better when things are rocky,” he concedes, mentioning 2011 and 2015 — recent years when his funds rose by double digits — as examples. But “at the end of a long bull market, like 1999 and today, no one thinks they need it. No one thinks they need insurance until it’s too late.”
Kynikos peaked at nearly $7 billion in assets at the end of 2008, the year of the global financial meltdown, when the firm’s long-standing U.S. short fund, called Ursus — the Greek word for “bear” — gained 44 percent net of fees. That year a New York magazine profile dubbed Chanos the “catastrophe capitalist” — a reminder that short-sellers typically succeed when others lose money, which is one reason they are not that popular in many quarters.
But since 2009, Ursus has lost about 70 percent of its value — 11 percent on an annualized basis — and is now less than $100 million, making it a relatively insignificant portion of the firm’s overall assets. Although Kynikos’s Tesla short may be in the money for the year, Ursus was down 19.3 percent through July, according to a recent report to investors.
The secret to Chanos’s longevity as a short-seller is Kynikos’s flagship fund, the vehicle where Kynikos partners invest, which was launched alongside Ursus in 1985. Kynikos Capital Partners is 190 percent long and 90 percent short, making it net long. Unlike most long/short hedge funds, however, the longs are primarily passive, using such instruments as exchange-traded funds, as the intellectual effort goes into the short side.
Chanos argues that by protecting the downside with his shorts, an investor can actually double his risk — and over time that has proved a winning strategy. Through the end of 2017, Kynikos Capital Partners has a net annualized gain of 28.6 percent since launch in October 1985, more than double the S&P 500. That has happened even though the short book — as represented by Ursus — has lost 0.7 percent annually during the same time frame, according to a recent Kynikos document Institutional Investor has obtained.
“It’s one of the greatest records ever,” says one fellow hedge fund manager, initially skeptical of the results. “No one has made a 28 percent annual return since 1985.”
The increased gross leverage — offset by virtually breaking even on the short side — helps explain the returns. However, as is the case with most hedge fund managers who’ve been around for decades, the big money was made in the early years.
In 1990, Kynikos was one of the top-ten hedge funds in the world, with Ursus running $660 million, according to Chanos. After a few rough years, that fund was down to $150 million before an investment by the Ziff brothers — known for their savvy investments in hedge funds — saved the firm in the mid-’90s when they invested in Kynikos Capital Partners.
The Ziff brothers unwound their hedge fund investments and withdrew their money from Kynikos in 2015. That year Chanos opened up Kynikos Capital Partners to other outside investors, along with a sister international fund, Kynikos Global Capital Partners, launched in 1996. The two 190/90 funds have raised more than $350 million since 2015 and now account for about half of the firm’s assets.
Unfortunately for the new investors, Kynikos Capital Partners has not done as well since 2015. Including a 9 percent loss through July of this year, the fund has a net annualized return of 4.86 percent since 2015, compared with the S&P 500’s return of 12.17 percent during the same time period.
Unsurprisingly, Chanos admits that running his hedge fund has been “no fun” lately.
But he keeps plugging away at it. “When you talk to him about companies, he is encyclopedic on them,” says noted short-seller Carson Block, the founder of Muddy Waters Research. “This is a guy who absolutely does his work.” Block is particularly impressed that at Kynikos the idea generation comes from Chanos and his two senior partners, whereas at most hedge funds that task is farmed out to junior analysts.
The frauds — or suspected frauds — that make for such compelling stories constitute only 25 percent of Kynikos’s shorts. “You can’t fill a portfolio with accounting frauds,” Chanos says. The rest are business model problems, leveraged balance sheets, or consumer fads. “We love getting killed on those right now,” he deadpans.
The reason doesn’t really matter to investors, who pay a 1 percent management fee and a performance fee of between 15 percent and 20 percent. As Jim Grant notes of Chanos, “His day job is to make money for his investors. They didn’t entrust him with their funds to be Captain Ahab searching for the great white whale.”
Kynikos’s poor performance and the massive redemptions of recent years are the type of news that would be used to castigate other hedge fund managers.
Chanos appears to be in a different, and unique, category.
“I’m an admirer, and I’ve become more of one as I’ve gotten to know him better over the years,” says Bethany McLean, a journalist whose career was jump-started by her Fortune magazine coverage of Enron, with Chanos as her source. “Regardless of whether he’s right or wrong — particularly right or wrong timing-wise — he’s always worth listening to,” she explains.
Frank Partnoy, a professor at the UC Berkeley School of Law, looks at it another way: “How do we judge people in other enterprises where the probability of success is not that high? You can poo-poo short-selling, but within the world of short-selling, he’s LeBron James. If you look at the announcement of an intervention by a short-seller, the market reaction to Kynikos is very significant.”
Chanos admits that he has been wrong on “tons” of his shorts. “Our batting average is about 65 to 70 percent. So a third of the time we’re wrong,” he says, on “hundreds and hundreds of stocks.”
Recently, the batting average has been worse, according to Activist Insight Shorts, which tracks short calls. Of his publicly announced shorts over the past three years, only five of the 13 companies Chanos has talked about have gone his way. The winners are Cheniere Energy, Solar City (taken over by Tesla when it was approaching bankruptcy), Mallinckrodt, CarMax, and Mednax. The losers include Tesla, Dunkin’ Donuts, Envision Healthcare, Restaurant Brands, Continental Resources, Express Scripts, Alibaba, and CNX Resources.
One of Chanos’s few losing shorts that drew media criticism was an ugly battle with Canadian insurer Fairfax Financial. Flame-throwing journalist Matt Taibbi criticized the short-sellers in his book The Divide: American Injustice in the Age of the Wealth Gap, saying that hedge fund moguls Dan Loeb and Steve Cohen, among others, had followed Chanos’s lead and ganged up to drive down the shares of Fairfax. (The company sued the hedge fund managers in a New Jersey court, but the case against Kynikos was eventually thrown out on jurisdictional grounds, with Fairfax losing its final appeal last year.)
The short-sellers argued that Fairfax was underreserved, which turned out to be true. But ultimately it didn’t matter, as Fairfax made up for its deficiencies with a timely subprime short during the financial crisis.
Chanos concedes that the critics had one good argument. The short-sellers had hired a third-party researcher, Spyro Contogouris, who turned out to be a “bad guy” who engaged in unsavory behavior that confirmed the public’s worst suspicions of short-sellers. “As soon as we found that out,” Chanos says, “we fired him.”
Chanos likes to say that short-sellers are born, not made, but there seems little in his early life to predict his iconoclastic future.
James S. Chanos was raised in Milwaukee, Wisconsin, the son of a second-generation Greek immigrant who ran a chain of dry cleaners. During the market’s “go-go” years of the 1960s, the elder Chanos invested on the side and counseled his son to learn about the stock market.
The lanky youth played basketball in high school, read everything he could on the market, then went to Yale, where he studied economics and political science — and started trading options.
Like many short-sellers, Chanos got into the business almost by accident, when, as an analyst at Gilford Securities in 1982, he was tasked with analyzing Baldwin-United and realized that the company’s financials were a sham, which he promptly revealed. The stock tanked, Baldwin-United filed for bankruptcy, and soon clients like hedge fund maestro Michael Steinhardt were asking for more short ideas.
Being right was a rush for the young analyst. Chanos moved up the career ladder to Deutsche Bank. But there were complaints after he was mentioned in a Wall Street Journal article that criticized short-sellers, and he was told his contract would not be renewed. “It was the greatest firing ever,” he says. Kynikos Associates was born that same year.
Some 33 years later he’s reflective. “There are disadvantages to being old,” says Chanos, whose sweep of sandy hair shows few traces of gray, though his craggy facial features indicate a fair amount of wear and tear. “Every once in a while, there’s an advantage. Because you’ve seen enough of these kinds of companies, when you start looking at one, you suddenly say, ‘I’ve seen this before.’ It doesn’t always work out that way, but at least it gives you an idea of maybe where to be looking.”
Valeant, the Canadian pharmaceuticals company that recently changed its name to Bausch Health Cos. in an effort to move beyond the scandals of recent years, was a case in point. When a Kynikos analyst made a presentation on Valeant to the senior partners in 2013, they lit up. “We looked at each other and said, ‘Tyco.’ It was run by the master of the aggressive roll-up, Dennis Kozlowski, back in the late ’90s,” he recalls. (Kozlowski served more than six years in a federal prison for stealing from the company.)
Even though Valeant’s stock doubled on him before it finally collapsed, Chanos realized it was going to be a successful short from day one. “I just knew it was going to be good because I saw all of the stars line up,” he says.
Valeant hasn’t been accused of wrongdoing, but Chanos still believes former CEO Michael Pearson, who was revered by Wall Street, deceived some of the most sophisticated investors in the world with aggressive accounting and predatory drug pricing. Valeant, Chanos asserts, was the largest single-stock hedge fund loss in history, as the stock shed $30 billion to $40 billion in market capitalization when it unraveled.
Chanos is drawn to the stories of bigger-than-life characters who were able to pull off history’s greatest frauds, like Swedish Match mogul Ivar Kreuger, immortalized in Frank Partnoy’s biography The Match King. The book is required reading in Chanos’s fraud class. As Chanos explains, “Kreuger was the consummate fraudster. He did a lot of good; a lot of his companies turned out to be successful. But he clearly crossed the line in numerous places. He was doing what he needed to do to save his empire.”
When the history books are written, will Elon Musk be viewed in a similar vein?
Unlike several other short-sellers, Chanos is cautious about calling Tesla a fraud. “There’s a lot of questionable activities, questionable accounting. But fraud needs intent,” he explains.
Chanos thinks the Tesla investigation offers the first big political test for the SEC under President Trump. Still, he isn’t counting on any action from regulators and says that Tesla might turn out to be a legal fraud, which is more common. In such cases, “there’s lots of intent to deceive, even though it might be covered by safe-harbor provisions and accountants and lawyers have signed off. And by the way, those things never get prosecuted.”
But short-sellers don’t operate in a court of law, Chanos notes. They’re in the stock market, where investing is a game of probabilities. And Chanos likes his odds on Tesla.
Musk’s recent comment on going private, he argues, was the “ultimate distraction” from the problems the CEO faces. He believes Musk has “handcuffed” himself by promising to be profitable and cash flow–positive during the second half of 2018. Meanwhile, there is evidence of production slowdowns in August and problems with the Model 3. “It’s looking to be a lemon,” Chanos says.
The company has also been stretching out payments to its suppliers — a sign its cash position is stressed. “The one thing about Musk is that he pulls rabbits out of the hat pretty easily, and who knows what he’ll come up with to try to meet the cash needs of the company?” says Muddy Waters’ Block. “But when you see the company asking for money back from its suppliers, you kind of feel like he’s out of rabbits.”
Since last December, Chanos has been predicting that Elon Musk will move on to SpaceX, his less controversial rocket company, within the next two years. Given the recent uproar over Musk’s leadership at Tesla, that might turn out to be a good thing for the company. On the other hand, what would Tesla be without its visionary leader? Ultimately, whether Musk stays or leaves, will Tesla be the first of this market’s highfliers to fall?
It’s a question on many short-sellers’ minds.
“We are for sure are in a Ponzi economics environment,” says Dan David, the co-founder of GeoInvesting, who got to know Chanos when both were featured in the documentary The China Hustle, about China stock frauds and the short-sellers, like David, who uncovered several, and Chanos, who has long been bearish on China.
“People end up getting more enthralled with the story than they are with the numbers,” David says. “That’s a mistake. When this market starts to crack, and they always do, there are a lot of investors who will come running to Chanos.”
He will still be there.
