Hedge Fund Market Wizards

Chapter 15

Joel Greenblatt

The Magic Formula

Joel Greenblatt’s name came up several times when I called hedge fund managers I knew for their recommendations on who I should consider including in a new Market Wizards book. One manager said, “He wrote this book, You Can Be a Stock Market Genius.” Responding to my muffled groan, he said, “Yeah, I know, the title, but it’s really a great book. I think that book got a lot of hedge fund managers in the business.” I subsequently read the book and found it covered the esoteric subject of special situation trading (spinoffs, mergers, restructurings, rights offerings, stub stocks, warrants, etc.) with surprising conciseness, clarity, and even a sense of humor.

In the appendix, Greenblatt provided the track record for his fund, Gotham Capital. The record began in 1985 and stopped abruptly in 1994. The average annualized compounded return was exactly 50.0 percent (before incentive fees). The outperformance was remarkably consistent. The lowest annual return during the entire 10-year period was positive 28.5 percent. It was one of the best track records I had ever seen. Why, I wondered, would anyone close a fund that was doing so remarkably well? Since it was clear from his books that Greenblatt remained active in the markets, I couldn’t even guess at a plausible explanation for closing the fund. The answer, it turned out, was both logical and obvious (once you knew it). Greenblatt closed his fund precisely because it did so well. Assets had ...