Geniuses Wipe Out Investment Funds
11th of December, 2018
One of my very first trades was a classic buy high and sell lower scenario. It was one of those defining moments that is forever etched into my memory and the lessons learned remain strong.
Back when I was starting out investing (read gambling there), I decided to buy a small mining stock Helix (HLX) on the basis of, well Greg the computer guy – he gave me the inside word. Yes, I thought I was a genius and was going to make a bucket of bills – ten-fold my money was the plan!
But you no doubt already know the end to this story and the subsequent lessons learned.
As you can appreciate, I took a beating the day I sold, both emotionally and financially, despite it being a small loss in the overall scheme of things.
Clearly, I was not a genius…. Nor was bloody Greg, who surprisingly as it turned out knew more about computers than he did investments!
But how often do actual geniuses get it wrong?
And how does this even happen? They are very bright and should know best?
The 1997 Nobel Memorial Prize in Economic Sciences
If you had to find one word to describe the winner of a Nobel Prize in Economic Sciences, what would it be?
Genius, extraordinary, talented, mastermind, intellect, intelligent or clever may spring to mind.
Now I’m not talking about the Ig Nobel Prize (Ig or Ignoble Nobel Prize is the parody of the Nobel Prize), this is the real one for the bigwigs, the intellectual heavy weights.
But what if I were to tell you the winners of the 1997 Nobel Prize in Economic Sciences were responsible for a gargantuan $4.6 billion loss in less than four months?
WTF! How does that even happen?
You may have heard about ‘Long-Term Capital Management (LTCM)’ and the subsequent loss they endured.
But you may not know the specifics of the intellects who were behind it. Yes, LTCM’s board of directors included none other than Myron S. Scholes and Robert C. Merton, who shared the 1997 Nobel Memorial Prize in Economic Sciences for a ‘new method to determine the value of derivatives’.
Their contribution to financial markets is one of the most significant of our time – the Black Scholes Option Pricing Model.
From Wikipedia, here is a snapshot of their formula. I’ll give you some time to mentally digest it 😉
So how could they get it so tragically wrong?
Smart people, blind spots and confidence levels
Have you ever met someone so smart that every answer they give is correct and provides intelligent insights into future opportunities?
What do you think would happen if they are continually right?
Let’s move away from intelligent people and jump over to the sports arena. Consider for a moment a professional boxer who has been undefeated in their professional career.
How confident do they appear in their press conference beforehand? What is their body language like? Do they act and talk like they own the world and will destroy their opponent?
Of course. They are overconfident.
As the famous philosopher Mike Tyson said, ‘Everyone has a plan until they get punched in the mouth.’
Travis Bradberry, president at TalentSmart, came to a similar conclusion with intellectual geniuses.
Bradberry wrote. “Smart people are more prone to silly mistakes because of blind spots in how they use logic. These blind spots exist because smart people tend to be overconfident in their reasoning abilities. That is, they’re so used to being right and having quick answers that they don’t even realise when they’re blowing it by answering without thinking things through.”
How to blow up a $200 million fund despite having written the book on the subject
Another case in point happened in November 2018.
A runaway market that blew up in the face of the genius fund manager losing massive sums on behalf of his clients.
Introducing, Natural Gas futures.
An impressive looking chart, isn’t it?
Not so for author and fund manager to 290 clients, who is now responsible for close to $200 million in losses in just 3 days.
James Cordier, is author of ‘The Complete Guide to Option Selling’ and founder of OptionSellers.com. He is an expert in his field. A highly respected authority on the subject.
So James, was writing naked calls on Natural Gas futures on behalf of his clients and was completely wiped out. Many of his clients now owe more than they invested originally including one investor who had invested $470,000 and now owes another $150,000…
“You can have a committee of 10 geniuses that proves collectively to be a moron.” Cliff Asness, Asset Manager.
Those who had funds with either LTCM or OptionSellers.com may use stronger words than moron but I reckon you get my point.
Models to guide us and make non-emotional investment decisions
The bottom line is, we are all human and make mistakes.
Markets remain the same because the underlying drivers, including human emotions, remain unchanged.
At Calnan Flack, we do everything we can to make non-emotional investment decisions. This is exactly what our Calnan Flack Economic Cycle Action Plan provides us with.
Our economic cycle action plan is our anchor point, our frame of reference and helps set our expectations.
Global markets have been in correction mode, with the S&P 500 and Aussie 200 index falling more than 10 per cent from recent highs to their respective recent low.
But we know this is just a correction and those in our forecast service know we are expecting markets to soon push higher.
Going back to my first trade at the start of this story, you can appreciate that the very next trade I made after my first big investment lesson was a fearful and tentative one.
I had no model. I had no plan. I was hopeful and had set my expectations to become rich.
Now with battle scars, hindsight, years of education and decades of research and market experience, our team has developed an economic model to remove human emotion and help foresee a looming crash before others.
Now is the time to turn off the Henny Pennies on CNBC and Bloomberg and remain bullish for the time being. We will be guided by our (repeatable) economic model and cycle drivers rather than by our emotions or some computer bloke called Greg!