Illustration: Anand Kumar
Most of us who have been reading about investing for a few years have come across the name of a hedge fund named Long-Term Capital Management (LTCM), which we know as a cautionary tale on how supposedly smart investors can lose enough money to wipe them out, personally and professionally. LTCM was established in 1994 by John Meriwether, a former vice-chairman and bond trading head at Salomon Brothers, and its board boasted esteemed members like Myron Scholes and Robert C Merton, who would receive the Nobel Prize in Economics in 1997 for creating the Black-Scholes option pricing model.
Initially, LTCM achieved amazing success, with after-fee annualised returns of 21 per cent, 43 per cent, and 41 per cent in its first three years. However, in 1998, it made a staggering loss of $4.6 billion in just under four months, mostly primarily due to its high-leverage Asian and Russian financial crises. This necessitated the intervention of the US Federal Reserve, which organised a bailout package amounting to around $3.6 billion to avert a wider financial meltdown.
One of LTCM's bond traders, Victor Haghani, has written a book named 'The Missing Billionaires'. The book's central argument is rather provocative. It says that over the last hundred years, if the wealthiest families had wisely spent a portion of their wealth, paid their taxes, invested in equities, and transferred their assets to the subsequent generations, today we would see tens of thousands of billionaires who inherited age-old fortunes. Yet, the enigma of 'The Missing Billionaires' is the absence of such heirs on contemporary wealth lists. While there are several reasons for this, Haghani and his co-author James White claim that this is because of a critical error that is relevant to every investor, even those at our scale: improper risk assessment. The book says that many of these families didn't necessarily make poor investment choices; rather, they misjudged the scale of their investments.
This idea actually sounds like an apology for Mr Haghani's own missing billion. As he has confessed in the book, he personally lost a sum in 'nine figures' in the LTCM collapse, which was his own doing. So if he lost a few hundred million dollars 25 years ago, he must be missing more than a billion dollars now. While I agree that everyone should invest better, I'm more than a little sceptical of this business of 'misjudging scale', which is just a roundabout way of saying that people invested too much in a few things. Isn't that just a way of saying that they should have diversified? Yes, of course, it is!
That's all there is to it. People should be diversified on where they invest and how much they invest in each type of investment and they (or at least many of them) will gradually generate wealth and be able to keep it. All you need to do is not to have too much exposure in one investment or even one kind of investment and you will never face a situation where you lose a major proportion of your net worth.
In fact, the idea goes even further. As I wrote in these pages a long time ago, 'you diversify your investments and your investments diversify you,' meaning that your investments can help you diversify your life itself. When COVID-19 started, many people found their careers stagnant or shaky. Generally, they found it hard to switch to another industry which had better prospects. That's because, after a decade or two of working in a kind of a job, they had become good at it, but also become its prisoner. In my observation, people who have good savings accumulated at such a point generally manage to weather the crisis and adjust their career path to something better. They are able to diversify their life. In a genuine sense, their investments provide them with the ability to diversify their lives.
Mr Haghani's missing billionaires were not able to do that, but people with far less money can if they just stick to this basic principle.
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