History repeats. It just looks different

September 1998 is when the star-studded hedge fund Long Term Capital Management (LTCM) was wound up. Large institutional investors bailed it out. One bank – Bear Stearns,  refused to participate.

A decade later, Bear Stearns was bought over by J P Morgan Chase. Trouble at the bank had started after two of its hedge funds got into trouble.

Reason for failure of LTCM – derivative trades using leverage

Reason for failure of Bear Stearns’ hedge funds – derivative trades using leverage

History repeats. It just looks different.

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Black swan

September 11, 2001 – the world witnessed an event that nobody had anticipated. The twin towers of the World Trade Centre at Manhattan, New York were blown away using aeroplanes of a US airline.

This was a “black swan” event – an event that one could not envisage. However, the probability of such an event is near zero and not exactly zero.

Be aware. A black swan phenomenon is one that even experts could not foresee.

in the financial markets, the collapse of LTCM was one such event. Read more about it in the book …

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When genius failed …

Two days ago, we wrote a post referring to an article titled, “The world’s smartest investors have failed …

There are numerous instances when the experts, the smartest in their respective fields, the best in the business, the genius have failed. Failure happens. When, where, how, why – these are questions that often have no answers. However, in certain cases, the answer to the “why” lies in one’s overconfidence, ego, refusal to learn – it’s all in the mind.

Just as a reminder, we have borrowed the title of today’s post from a book by the same name, written by Roger Lowenstein, highlighting how a team of the best in the business failed at their own game. It is a compelling story of a very large investment fund – Long Term Capital Management. Managed by Nobel Laureates, the fund could not live up to its name even and did not survive the “long term”. In “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”, we have a chapter on this episode.

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When genius failed

As per the Institutional Investor magazine, “They (LTCM) are in effect the best finance faculty in the world.”

Probably that is why Roger Lowenstein titled his book giving an account of the rise and fall of LTCM “When Genius Failed”.

Read the chapter on LTCM in the book “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”

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Lehman Brothers or Lehman Sisters

I am back tweeting about the book after a long gap. On this day, International Women’s Day, it would be appropriate to pay a tribute to all the wonderful ladies in my life.

In the year 2008, Lehman Brothers collapsed and filed for bankruptcy. Someone said, “It wouldn’t have collapsed had it been Lehman Sisters”.

Yes, women are believed to be wiser than men when it comes to financial decisions. Please read again – the key word is “wise”, and not “intelligent” or “knowledgeable”.

History suggests that eventually wisdom wins over intelligence. The men at Lehman Brothers, and even at many other firms were intelligent and knowledgeable. However, history also tells us that we don’t learn from history.

Lehman Brothers went bust in 2008. It was just a decade ago in 1998 that they had the best view of what went wrong with Long Term Capital Management. Lehman Brothers were custodians for LTCM.

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Murphy’s Law

Someone forwarded a message on social media listing Murphy’s Laws. One of those caught my attention:

“If everything seems to be going well, you have obviously overlooked something”

In the world of investing, if a risk is not visible, it is a reflection of our inability to see the risk not the absence of the risk.

Exactly the same has happened time and again in the history of financial markets.

This is exactly what happened with Long Term Capital Management (LTCM). (See our post of 31st Dec 2015 on the same).

The problem with LTCM was, the risk was very much there, except that it was not obvious.

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Low risk – high returns: is it a problem?

In the words of Prof. Myron Scholes, “Well, our (LTCM’s) goal is to get the risk level of S&P 500. We are having trouble having it that big.”

The problem Long Term Capital Management (LTCM) was not about getting enough returns, but about having enough risk.

Something was missing here. The fund was generating extraordinary returns, without commensurate risks, as is evident from Prof. Scholes’ statement above.

Read more about the lessons from the LTCM episode in “Riding The Roller Coaster – Lessons from financial market cycles we repeatedly forget”

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