In 1998, one of the world’s biggest hedge funds collapsed into nothing.
That hedge fund was Long-Term Capital Management (LTCM).
It was the brainchild of John Meriwether, a legendary bond trader at Salomon Brothers.
Meriwether (and other so-called geniuses) started LTCM as a small hedge fund in 1994.
By 1998, LTMC had attracted more than $1 billion of investor capital. But then, it collapsed under the weight of its bets and hubris.
And as I’ll show you below, with the markets in turmoil… and major collapses like FTX, Voyager, and Celsius rocking the investment world again… there is an important lesson we can take away today.
Hottest Trade in London
Eventually, the New York Fed and 14 Wall Street banks bailed LTCM out… mostly because the other big Wall Street banks had exposure to it.
But one firm didn’t come to LTCM’s rescue: Bear Stearns.
I worked for Bear at the time. I ran its analytics group in London.
In 1998, the buzz around town was that a new combination currency would surface in 1999 – the Euro…
And when it did, Germany would pull all the weaker European countries up by its bootstraps.
Certain investors believed that even countries that weren’t going to be part of the Euro would benefit, like Russia.
But that’s where LTCM ran into trouble…
One of LTCM’s bets was that Russian bonds would increase in value relative to German bonds. In Wall Street speak, we call this a “convergence” trade.
Now, my team was also recommending convergence trades to our clients. But nowhere near to the extent – or with the leverage – that LTCM was doing them.
And convergence was an extremely choppy path.
When the Russian ruble crashed and Russia defaulted, that meant that being long Russia vs. Germany, in any way, was a trade headed for disaster.
This was before 24/7 business news media. But word traveled fast at the pubs around where I worked, in London’s Canary Wharf district…
When it became clear that a big shoe was about to drop… and LTCM was struggling to unwind its position… we all scrambled to contain our clients’ exposure.
It Pays to Take the Long View
Fortunately for our clients, we weren’t directly involved in the Russia-Germany play. And we hadn’t recommended leveraged convergence positions.
So we recommended they sit on most of their positions until the dust settled.
Still, our clients weren’t happy about the market chaos during the LTCM and Russian ruble debacle.
A year earlier, there had been another bout of intense currency volatility with the Asian financial crisis. They had wanted to move past the choppiness. And here was LTCM messing everything up again!
Some chose to exit their positions to avoid things getting worse, and they took small losses. But others stayed in the convergence trade longer and did very well.
One major British bank client sold two shorter-term positions at a small loss. But they held the rest of their investment through the latter part of 1999, as the Euro was born. And they nearly doubled their money on that.
What This Means for Your Money
The point is, if your strategy is solid, it’s best to take a longer view.
This applies to the stock market today as much as it applied to my clients at Bear Stearns back in the ‘90s. As for LTCM…
In 1998, around 3,200 hedge funds managed about $210 billion in assets combined. LTCM’s collapse didn’t stop the industry from growing.
Today, there are more than 11,000 hedge funds, and their assets have swelled to more than $4 trillion.
So if you’re feeling anxious about the awful markets we had in 2022, remember this…
At the end of the day, even if one or two companies in a sector go bust, others will be happy to pick up the pieces.
That’s why it’s prudent to spread your risk – even when investing in what seems like an amazing opportunity.
Never invest all your capital in a single name or idea. And invest in small increments rather than all at one time.
If you like an idea, consider investing half of what you’d allocate to it now… and half in a few months or when you see a dip.
You can also consider investing smaller amounts over a longer period. We call this “legging in” or “dollar-cost averaging.”
None of us can time the market with 100% accuracy. And none of us can get every investment right.
But this approach can help you protect your nest egg if one of your investments doesn’t work out.
Regards,
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Nomi Prins
Editor, Inside Wall Street with Nomi Prins
P.S. As I wrote above, spreading your risk and taking a long-term view of the market are key to securing your nest egg in the years ahead…
But when it comes to 2023, I believe the government has already picked the biggest winners and losers.
That’s why I’m hosting a strategy session next Thursday, January 12 at 8 p.m. ET to pull back the curtain on what I know.
I’ll show you a little-known strategy that will give you a chance to profit from the winners and losers – at the same time. And I’ll even give you the name of one stock to buy… and one to avoid… for free.
So be sure to RSVP with one click right here. And mark down Thursday, January 12 on your calendar.