Investing, Or Gambling ?

The London Paper  –  25 Sept 2006

What I’m about to tell you is so preposterous, even by the ridiculously high standards of the City, that even I was shocked. You literally couldn’t make this stuff up. Last week a large, well-respected hedge-fund called Amaranth (crazy name, crazy company) lost around two thirds of its value ($6bn!) in just a week or so as a result of its bet that the US gas price would go up proving erroneous. Several other funds had followed suit. Now, this huge punt was itself based on the assumption that hurricanes would cause gas supply disruptions around this time of year. So investors have lost over half their cash because a few comedians took a bet on US weather conditions! Haven’t these people ever heard about the effect a butterfly flapping its wings in China can have? You might as well have had a flutter on ‘Little Joe’ at the 12.15 at Doncaster.

The problem is that if a few large bets work out then an individual hedge fund manager could personally make millions whereas if he loses out the worst that can happen is that he loses his job. Whilst this may seem like a reasonable disincentive my experience suggests that the size and inefficiency of the global financial services market is such that these jokers usually end up somewhere else pretty quickly – ready to lose money for some other clients.

Now I, like most cityboys, will aggressively bet on absolutely anything. Last week, during a football match I attended with clients, I counted around 30 individual wagers ranging from the time of the first goal to the size of the bra cup of some salad dodger sitting in front us. But the trouble with our love of gambling is that it has influenced the way we operate professionally. We brokers and fund managers love to claim that we ‘invest’ cash long-term but we all know the old adage that ‘a long-term investment is just a short-term bet gone wrong’. With the general ‘hire and fire’ culture making everyone think short-term, perversely a risky punt on some possible near-term take-over candidate sometimes seems more sensible than investing in some solid company with long-term prospects.

The major drawback with all this is that when this house of cards does come tumbling down (and it will) people who invested in good faith in certain seemingly solid funds will find, just like those suckers who invested in Amaranth, that they might as well have gone into a casino and put all their money on black. I’m about to tell you is so preposterous, even by the ridiculously high standards of the City, that even I was shocked. You literally couldn’t make this stuff up. Last week a large, well-respected hedge-fund called Amaranth (crazy name, crazy company) lost around two thirds of its value ($6bn!) in just a week or so as a result of its bet that the US gas price would go up proving erroneous. Several other funds had followed suit. Now, this huge punt was itself based on the assumption that hurricanes would cause gas supply disruptions around this time of year. So investors have lost over half their cash because a few comedians took a bet on US weather conditions! Haven’t these people ever heard about the effect a butterfly flapping its wings in China can have? You might as well have had a flutter on ‘Little Joe’ at the 12.15 at Doncaster.

The problem is that if a few large bets work out then an individual hedge fund manager could personally make millions whereas if he loses out the worst that can happen is that he loses his job. Whilst this may seem like a reasonable disincentive my experience suggests that the size and inefficiency of the global financial services market is such that these jokers usually end up somewhere else pretty quickly – ready to lose money for some other clients.

Now I, like most cityboys, will aggressively bet on absolutely anything. Last week, during a football match I attended with clients, I counted around 30 individual wagers ranging from the time of the first goal to the size of the bra cup of some salad dodger sitting in front us. But the trouble with our love of gambling is that it has influenced the way we operate professionally. We brokers and fund managers love to claim that we ‘invest’ cash long-term but we all know the old adage that ‘a long-term investment is just a short-term bet gone wrong’. With the general ‘hire and fire’ culture making everyone think short-term, perversely a risky punt on some possible near-term take-over candidate sometimes seems more sensible than investing in some solid company with long-term prospects.

The major drawback with all this is that when this house of cards does come tumbling down (and it will) people who invested in good faith in certain seemingly solid funds will find, just like those suckers who invested in Amaranth, that they might as well have gone into a casino and put all their money on black.

Thoughts ?

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