Long Term Capital Management and the Dangers of Debt

This is a good documentary about the ’90s hedge fund Long Term Capital Management (LTCM). If you want to learn more you should read Roger Lowenstein’s excellent bookWhen Genius Failed.

The story is a cautionary tale about leverage (leverage: what rich people call debt). LTCM was leveraged 25-1, meaning a 4% reduction in assets would kill the firm. That’s precisely what happened.

LTCM would make ‘safe’ bets and leverage up on those safe bets to amplify returns.  It worked great for years, until 1998 when the world defied the model with Russia’s default.

Leverage boosts returns but it blows up in your face when you are wrong, no matter how brilliant you are. Everyone gets things wrong.  That’s a part of life.  That’s a part of investing.  In the face of an error, the proper course of action is to pick up the pieces and move on.  Excessive leverage destroys the ability to do that, because one mistake will wipe you out.  LTCM had two Nobel Prize winners and one of the greatest bond traders of all time, John Meriwether.  If they can get things wrong, then anyone can.

Whenever I hear of the returns of Renaissance Technologies, I think of LTCM. Genius minds, complex mathematical models, massive returns and leverage. They may not be leveraged 25-1, but they are reportedly leveraged 17-1.

PLEASE NOTE: The information provided on this site is not financial advice and I am not a financial professional. I am an amateur and the purpose of this site is to simply monitor my successes and failures. Full disclosure: my current holdings.

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