Both big investors were on the verge of losing everything after borrowing too much, like Bill Hwang
The road to investment fortune is paved with debt. George Soros’ use of it earned him about $ 2 billion on his bet against the pound. But leverage is even more effective in reverse, as Bill Hwang and his struggling family office, Archegos Capital Management, have discovered. The managerhedge funds of Korean origin is in good company. Two of the greatest investors of all time, Benjamin Graham and John Maynard Keynes, came close to losing everything after going into too much debt. Fortunately, they survived to learn from their mistake.
Archegos leveraged its 10 billion capital up to nine times, according to the media. Presumably, debt contributed to its mind-blowing returns after starting its journey in 2012, with assets of just $ 200 million. That Hwang’s investments were concentrated in a handful of Chinese internet firms, along with a huge bet on ViacomCBS, further magnified the risks. Losses in the company’s shares triggered the margin calls (supplemental coverage lawsuits) that soon blew up Hwang’s multi-million dollar fortune.
Almost a century ago, Graham and Keynes found themselves in a similar situation. Towards the end of the roaring twenties, they raised their profits with large amounts of debt. They did not see the storm clouds. Following the crash, Graham’s fund lost 70% of its value. He, who had just rented a posh duplex in Manhattan with valet parking, had to tighten his belt. The dean of Wall Street, as he would come to be known, went on to elaborate 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 and invested heavily on his own. He regularly speculated in commodities and currencies and, like Hwang, maintained a concentrated portfolio of leveraged common stocks. But in 1928 he had to face margin calls after some of his bets went wrong. Its largest equity position, Austin Motors, would lose three-quarters of its value. By the end of the 29th, his net worth was down 80% from the high of a couple of years earlier.
Like Graham, Keynes learned valuable lessons. First, he gave up applying his knowledge to predict business cycle movements. Like Graham, he adopted the discipline of buying stocks below their intrinsic value. Both insisted that their acquisitions have a “margin of safety” to protect against losses. Graham opted for cheap stocks relative to their book value, and Keynes emphasized the quality of the companies, anticipating Buffett. “When the safety, excellence and cheapness of a stock are generally recognized,” he asserted, “its price is bound to go up.”
They both invested for the long term, holding positions through thick and thin. They viewed the market as susceptible to violent mood swings, and tried to take advantage of turbulence, when investors are most fearful: “It is largely fluctuations that make bargains emerge and the uncertainty due to them that prevents let other people take advantage, ”Keynes pointed out. He earned a reputation for being quick when he saw a bargain.
Keynes’s investments were highly concentrated. In 1931, he only owned shares in two automobile companies, both British. As in Mark Twain’s adage, “Put all your eggs in one basket and keep an eye on that basket.” After 1929, it enjoyed extraordinary success, outperforming the benchmark two out of three years. His net worth, which had sunk below 8,000 pounds, surpassed 500,000 in 1936. It is more than Hwang achieved in a somewhat longer time.
Investing long-term in a concentrated portfolio, while taking advantage of market opportunities as they arise, is not compatible with operating on leverage. The heavily indebted, like Hwang, face margin calls when the market falls and they are not in a position to take advantage of the bargains. On The Intelligent Investor, Graham stated that holding stocks on margin was “ipso facto speculating.” Buying internet or tech stocks on margin, as Hwang did, is even more risky. Keynes agreed with his counterpart, noting that “an investor who sets out to ignore short-term fluctuations needs greater security resources and should not operate on such a large scale, if at all, on borrowed money.”
In public, Keynes continued to lash out at speculation. His General Theory of Employment, Interest, and Money famously says, “When the development of a country’s capital becomes a by-product of the activities of a casino, the job is likely to be poorly done.” But privately he couldn’t resist a leveraged gamble. In 1936, the year of the book, its position in the wheat market grew so much that it was equal to the British monthly consumption. It is said that he considered the option of accepting the delivery and storing the grain in the chapel of King’s College, Cambridge, where he was treasurer. When the stock market crashed the following year, his equity fell by almost 60%. These losses were never fully recovered in the life of the economist.
He loved risk. “The professional investment game is intolerably boring and demanding for those who are totally exempt from the instinct to gamble,” he wrote, “while those who have it must pay the corresponding toll on this propensity.” This observation, like all other insightful comments on the General Theory, is based on your personal experience. Hwang now pays the “corresponding toll.”