This is the third in my series of posts (first and second) on Long Term Capital Management, a hedge fund which blew up in 1998. Much of the following information comes from the book When Genius Failed – The Rise and Fall of Long-Term Capital Management.
From their new headquarters in Greenwich, Connecticut, John Meriwether and his merry band of geniuses, began to work their magic. They started relatively slow at first. The first two months – no profits. Then, like the calm before an avalanche, the profits began to roll in. There was significant trouble in the bond market back in 1994. The trouble started in the US and spread across Europe. This widened interest rate spreads and made for more investment opportunities for LTCM.
At the end of their first year, LTCM could look back on a extremely respectable 28% rise in total assets. They were proving to everyone that they were, the brightest guys in the room. They found investment opportunities everywhere. Because they were using arbitrage trading, they were buying and selling at the same time. This allowed them to mitigate risk. For example, if you’re buying U.S. Treasury 30 year notes due to expire in January 1995, for example, because their interest rates are “relatively” low and you are selling U.S. Treasury notes that are due to expire several months later because their interest rates are “relatively” higher than you’ve balance the risk.
LTCM looked for these fixed income trades all over the world. They traded in Japan, Singapore, Hong Kong, Mexico, Brazil, Italy, Egypt, Russia and many places in between. They clearly took advantage of the new computer technology in order to facilitate trading. They were the best and the brightest. They believed in their company. The partners initial investment of $150 million had grown to a stake of $1.4 billion. Again, this is not the total worth of the company instead, this is the amount of money that the partnership poured back into the company because they knew they were on the right track. They were riding the golden goose. Total profits in 1996 were a mindnumbing $2.1 billion.
Then, as if written by Hollywood, the two whiz kids, the two geniuses at long-term capital management, Merton and Scholes won the Nobel Prize in economics. The good times were truly rolling. Seriously, who wouldn’t want to be a hedge fund manager? This is great.
