(The author is a Reuters Breakingviews columnist. The opinions expressed are his own. Refiles to correct punctuation in paragraph eight.)
By Edward Chancellor
LONDON, April 6 (Reuters Breakingviews) – The road to investment fortune is paved with debt. George Soros’ use got him about $ 2 billion from his bet against the British pound on what became Black Wednesday in September 1992. But the leverage is even more effective in reverse, because Bill Hwang and the lenders at his stricken family office, Archegos Capital Management, have found out. The Korean-born hedge fund manager is in good company. Two of the greatest investors of all time, Benjamin Graham and John Maynard Keynes, both nearly died after taking on too much debt. Fortunately, they survived to learn the error of their ways.
Archegos has used up to nine times its capital of $ 10 billion, according to published reports. Debt arguably contributed to the stunning returns after the fund launched in 2012, with assets of just $ 200 million. The fact that Hwang’s investments were concentrated in a handful of Chinese internet companies, along with a massive bet on ViacomCBS, the media company, further magnified the investment risks. Losses on ViacomCBS shares sparked margin calls that quickly blew Hwang’s multibillion-dollar fortune.
Almost a century ago, Graham and Keynes found themselves in a similar situation. Towards the end of the Roaring Twenties, the two investors improved their returns thanks to significant indebtedness. Neither saw the storm clouds gather over Wall Street. After the October 1929 crash, Graham’s investment fund lost 70% of its value. Graham, who had recently rented a posh duplex in Manhattan with valet parking, was forced to tighten his belt. The “Dean of Wall Street,” as Graham later became known, then developed the conservative principles of value investing, which guided his disciple Warren Buffett to fabulous wealth.
In the late 1920s, in addition to being England’s most famous economist, Keynes held various positions in the City of London and invested heavily on his own. He regularly speculated in commodities and currencies and, like Hwang, held a concentrated portfolio of leveraged common stocks. In 1928, however, the Cambridge economist faced margin calls after some of his bets deteriorated. Keynes’ largest stock position, Austin Motors, then lost three-quarters of its value. By the end of 1929, his net worth had fallen 80% from its peak a few years earlier.
Like Graham, Keynes learned valuable lessons from this heartbreaking experience. First, he gave up trying to apply his economic expertise to predict the movements of the business cycle. Instead, like Graham, Keynes has adopted the discipline of buying stocks below their intrinsic value. Both investors insisted that their share purchases come with a “safety margin” to protect them against losses. While Graham has opted for stocks that are cheap relative to book value, Keynes has emphasized the quality of the companies in which he has invested. In this regard, Keynes anticipated Buffett’s investing style. “When the safety, excellence and affordability of a stock are generally realized,” he said, “its price is bound to go up.”
Graham and Keynes have both invested with a long-term horizon, holding positions through thick and thin. They saw the stock market as prone to violent mood swings and sought to profit from times of market turmoil when investors are particularly fearful: them, ”noted Keynes. He has gained a reputation for being quick whenever he spotted a good investment deal.
Keynes’ stock market investments have been very concentrated. By 1931 he owned shares in only two companies, both of which were British car manufacturers. Its investment philosophy is summed up by Mark Twain’s adage: “Put all your eggs in one basket and watch that basket. After 1929 Keynes had extraordinary investment success, outperforming the benchmark two out of three years. His net worth, which by the end of 1929 had fallen below 8,000 pounds, topped 500,000 pounds by 1936. This 62-fold increase is greater than what Hwang achieved over a slightly longer period.
Investing for the long term in a concentrated portfolio of stocks, while simultaneously taking advantage of market opportunities as they arise, is not compatible with leveraged operation. Heavily indebted investors like Hwang face margin calls when the stock market goes down and are unable to get a good deal. In “The Intelligent Investor” Graham said that holding stocks on margin was “ipso facto speculation”. Buying Internet or tech stocks on margin, as Hwang did, is even riskier. Keynes agreed with his US counterpart, noting that “an investor who offers to ignore short-term market fluctuations needs more resources for security and should not operate on such a large scale, if at all. everything with borrowed money “.
In public, Keynes continued to speak out against speculation. His “General Theory of Employment, Interest, and Money” contains a famous warning that “when the development of a country’s capital becomes a by-product of a casino’s activities, labor is at risk. to be badly done “. But privately, Keynes couldn’t resist a leveraged bet. In 1936, the same year that the “General Theory” was published, its position in the wheat market became so important that it was equivalent to the total monthly consumption of Great Britain. Keynes reportedly considered taking delivery and storing the grain in the Chapel of King’s College Cambridge, where he was Bursar. When the US stock market plunged the following year, Keynes’ net worth fell almost 60%. These losses were never fully recovered during his lifetime.
The truth is, Keynes liked to gamble in the markets and found prudent investing somewhat boring. “The game of professional investing is intolerably boring and overkill for anyone who is entirely devoid of the instinct of the game,” he writes, “while whoever has it must pay the proper toll for this propensity.” This remark, like all of the other insightful investment comments in “General Theory,” is based on Keynes’ personal experience. Hwang, who was playing with much more leverage than Keynes, now pays the “appropriate toll.”
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