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.

2 thoughts on “Long Term Capital Management and the Dangers of Debt”

  1. Hey Value Stock Geek,
    I love your stuff so far, I’m trying to reread from the beginning and regardless of performance or holdings you are definitely extremely well read on the topic of investing. That’s something that always appeals to me.
    However, do you consider at all the fact that machine learning and A.I. have become so advanced that companies like Renaissance Tech are much safer in doing what LTCM tried to do? Quite frankly, Renaissance Tech’s track record is something that has never been accomplished before and may never be accomplished again (with annualized returns in great excess of 30% over a 20 year span).
    Sometimes it’s best to give credit where credit is due.
    Love your material though, I’ve been devouring it for the past few days (skipping around reading what sounded interesting until I decided a large enough % was interesting to warrant reading from the beginning).


    1. I appreciate the feedback! Thank you! You may be correct about RenTech. Track record is certainly amazing and those guys are way smarter than me, but so were the guys at LTCM. I just think that kind of leverage is dangerous, if what’s reported is true.


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