[Cover Image of When Genius Failed]

The recent collapse of the hedge fund Amaranth Advisors seemed to be a good time to read about the meteoritic rise and spectacular fall of Long-Term Capital Management, a hedge fund run by some really smart people that imploded in a matter of weeks and threatened to take down the world capital markets that the U.S. Federal Reserve was compelled to intervene.

The book, written by financial journalist Roger Lowenstein, tells a gripping tale of the founding of LTCM by John Meriwether, the assembling of a team of brilliant partners including two future Nobel Memorial Prize winners, the initial years when the fund was able to successfully play the arbitrage opportunities in the bond market and finally the fall triggered when Russia defaulted on its bonds and investors fled en masse to the safety of Treasury bonds. The fund, founded in 1993, earned 40% a year with little or no volatility for over four years before losing it all in just five weeks in the fall of 1998.

The LTCM story holds a valuable lesson for investors (other than avoiding hedge funds like the plague): When outsized returns are earned, it means that outsized risks are being taken, even if the fund is run by very smart people. The book is excellent and is definitely worth checking out.

This article has 8 comments

  1. While I agree that hedge funds are a dangerous gamble with your money, I have to disagree with the statement that outsized returns equate with outsized risk. Everyday smart investors are making significantly better than average returns without huge amounts of risk.

  2. Read “Running Money” by Andy Kessler, his personal experience of running hedge fund, excellent book.

  3. “When Genius Failed” is a great book. It’s very readable, like a Michael Lewis book. The story even has a Canadian connection as nobel prize winner, Myron Scholes is from Hamilton.

    I came across the book while reading “Smartest Guys in the Room”. It says that there were 2 books that every trader at Enron was told to read. One of them, oddly enough, was “When Genius Failed”.

  4. Canadian Capitalist

    Award: What was the other book that Enron employees were told to read?

    Alex: Thanks for the tip. I will check it out.

    James: I beg to differ. Can you give me an example of how a smart investor is making high returns without risk?

  5. I didn’t say without risk, nor did your blog. It said outsized risk.
    Warren Buffett is the age old example…very low risk but definately outsized returns

  6. Canadian Capitalist

    James: Good point. Mr. Buffett, of course, has a different definition of risk: do not risk capital, rather than the academic definition of variability of returns.

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