Quote of the month.
It’s not often we quote an economist. It’s not because we don’t like them. We just don’t have much faith in their ability to predict the future. And even if they get that right, markets don’t always react the way you expect them to. But this month we’re making an exception.
“As time goes on, I get more and more convinced that the right method of investment is to put large sums into enterprises which one thinks one knows something about and in the management of which one thoroughly believes. It is mistake to think that one limits one’s risk by spreading too much between enterprises about which one knows little and has no reason for special confidence.”
John Maynard Keynes, in a letter written August 15th, 1934.
Scientists estimate that during their heyday, around 20,000 Tyrannosaurus Rexes lived at any one time. Were you able to go back in time, a T. Rex would have been on average 25km from you. They hung around for a long time too, with an estimated 127,000 generations of the dinosaur living and dying in total.
This month in (financial) history.
August 15/16, 1945: Stock markets closed to celebrate the end of WW2.
August 1971: Alarmed at inflation, which was running at roughly 4.5% per annum, US President Richard Nixon declared a 90-day freeze on wages and prices. In response, the stock market soared by 3.8%. However, the freeze would not work. By 1975 inflation was running at over 11%. After a slight drop in the late 70s it hit 13% in 1980.
August 13, 1998: As Russia struggled economically, it put capital controls on the ruble, attempting to limit the currency’s decline. Russia’s stock market fell on the news, and at that point was down 75% since the start of 1998. Short term interest rates in Russia hit 200%. The panic was hurting one hedge fund in particular, who had investment assets leveraged at 25 to 1, much of which was used to bet heavily on Russian bonds. And it got worse. Russia would default on its bonds 4 days later. The hedge fund was Long Term Capital Management. Over the following five weeks, all equity in Long Term Capital Management (LTCM) would evaporate, leading to one of the biggest bailouts in corporate history.
LTCM was initially very successful. However, in 1998, investor capital all but disappeared in less than four months. Because many of the largest banks in the world had financed LTCM, it was feared outright failure could invoke a chain reaction in numerous markets, causing catastrophic losses to cascade through the financial system. LTCM tried, and failed to raise more money on its own, and it became clear it was running out of options.
On September 23, 1998, Goldman Sachs and Berkshire Hathaway offered to buy out the fund’s partners for a fraction of what the stake had been worth at the start of the year, and to inject enough funds to pay out the creditors. Warren Buffett gave LTCM less than one hour to accept the offer, but the time lapsed before a deal could be worked out.
Seeing no options left, and in stark contrast to how things are done these days, the Federal Reserve Bank of New York organised a bailout by the major creditors. No public money was injected or put directly at risk. The companies involved in providing support to LTCM were also those that stood to lose from its failure.
In 2007 Warren Buffett spoke about LTCM, and the folly of debt, during a talk to MBA students at the University of Florida. Here’s his comments on the investment team at LTCM. Pay attention.
“The whole story is really fascinating because…if you take the 16 of them, they probably have as high an average IQ as any 16 people working together in one business in the country…an incredible amount of intellect in that room. Now you combine that with the fact that those 16 had had extensive experience in the field they were operating in…in aggregate, the 16 had probably had 350 or 400 years of experience doing exactly what they were doing. And then you throw in the third factor that most of them had virtually all of their very substantial net worth in the business. So they had their own money up. Hundreds and hundreds of millions of dollars of their own money up. Super high intellect, working in a field they knew. And essentially, they went broke.
And that to me is fascinating…to make money they didn’t have and didn’t need, they risked what they did have and did need, and that’s foolish. Doesn’t make any difference what your IQ is. If you risk something that is important to you for something that is unimportant to you, it just does not make any sense. I don’t care whether the odds are 100 to one that you succeed or 1,000 to one that you succeed….you can name any sum you want but it doesn’t do anything for me on the upside and I think the downside is fairly clear. So I’m not interested in that kind of a game. And yet people do it financially without thinking about it very much.
There was a great book…“You Only Have to Get Rich Once.” Now that seems pretty fundamental, doesn’t it? If you’ve got $100 million at the start of the year, and…you’re going to make 10% if you’re unleveraged, and 20% if you’re leveraged, 99 times out of 100. What difference does it make at the end of the year whether you’ve got $110 million or $120 million? It makes no difference at all…It makes absolutely no difference. It makes no difference to your family. It makes no difference to anything. And yet the downside, particularly in managing other people’s money, is not only losing all your money, but it’s disgrace and humiliation, and facing friends whose money you’ve lost and everything. I just can’t imagine an equation that that makes sense for. And yet 16 guys with very high IQs who are very decent people, entered into that game…I think it’s madness.”
By the way, eventually the assets of LTCM were all sold. And the creditors themselves did not lose money from being involved in the transaction.
After helping unwind LTCM, founder John Meriwether launched a new hedge fund, JWM Partners. By December 1999, it was reported they had raised $250 million for a fund that would continue many of LTCM’s strategies – this time, using less leverage. Unfortunately, during the credit crisis of 2008, JWM Partners was hit with a 44% loss from September 2007 to February 2009 in its Relative Value Opportunity II fund. JWM was shut down in July 2009. Quite amazingly, Meriwether then launched a third hedge fund in 2010, using a similar investment strategy to LTCM. No word on how that worked out, but he did apparently raise over $100 million.
And finally…if aliens visited Sydney