In 1998, one of the world’s biggest hedge funds collapsed into nothing.

That hedge fund was Long-Term Capital Management, or LTCM.

It was the brainchild of John Meriwether, a legendary bond trader at Salomon Brothers.

Meriwether (and other so-called geniuses) started LTCM as a small hedge fund in 1994.

By 1998, LTMC had attracted more than $1 billion of investor capital. But then, it collapsed under the weight of its bets and hubris.

And as I’ll show you below, there is an important lesson we can take away today… especially as we head into potentially choppy markets next year.

Hottest Trade in London

Eventually, the New York Fed and 14 Wall Street banks bailed out LTCM. Mainly because the other big Wall Street banks had exposure to it.

But one firm didn’t come to LTCM’s rescue: Bear Stearns.

I worked for Bear at the time. I ran its analytics group in London.

In 1998, the buzz around town was that a new combination currency would surface in 1999 – the Euro…

And when it did, Germany would pull all the weaker European countries up by its bootstraps.

Certain investors believed that even countries that weren’t going to be part of the Euro would benefit, like Russia.

But that’s where LTCM ran into trouble…

One of LTCM’s bets was that Russian bonds would increase in value relative to German bonds. In Wall Street speak, we call this a “convergence” trade.

Now, my team was also recommending convergence trades to our clients. But nowhere near to the extent – or with the leverage – that LTCM was doing them.

And convergence was an extremely choppy path.

When the Russian ruble crashed and Russia defaulted, that meant that the drawn-out Russia vs. Germany, in any way, was a trade headed for disaster.

This was before 24/7 business news media. But in London’s Canary Wharf district, where I worked, word traveled fast at the pubs…

When it became clear that a big shoe was about to drop… and LTCM was struggling to unwind its position… we all scrambled to contain our clients’ exposure.

It Pays to Take the Long View

Fortunately for our clients, we weren’t directly involved in the Russia-Germany play. And we hadn’t recommended leveraged convergence positions.

So, we recommended they sit on most of their positions until the dust settled.

Still, our clients weren’t happy about the chaos in the markets during the LTCM and Russian ruble debacle.

A year earlier, there had been another bout of intense currency volatility with the Asian financial crisis. They had wanted to move past the choppiness. And here was LTCM messing everything up again!

Some chose to exit their positions to avoid things getting worse and took small losses. But others stayed in the convergence trade longer and did very well.

One major British bank client sold two shorter-term positions at a small loss. But they held the rest of their investment through the latter part of 1999, as the Euro was born. And they nearly doubled their money on that.

In the bigger picture, LTCM’s collapse didn’t stop the asset management industry from growing.

In 1998, there were around 3,200 hedge funds managing about $210 billion in assets. Today, there are more than 15,000 hedge funds, and their assets have swelled to more than $4.5 trillion.

What This Means for Your Money Today

Many on Wall Street – like J.P. Morgan and BlackRock – predict that volatility will jump next year. And that’s why I’m telling you my LTCM story today.

What it shows is that it often pays to take a longer view. That applies to the stock market today as much as it applied to my clients at Bear Stearns back in the ‘90s.

So, if you’re feeling anxious about the markets as we head into 2024, remember this… At the end of the day, even if one or two companies in a sector go bust, the other ones will be happy to pick up the pieces.

That’s why it’s prudent to spread your risk – even when you’re investing in what seems like an amazing opportunity.

Never invest all your capital in a single name or idea. And invest in small increments rather than all at one time.

If you like an idea, consider investing half of what you’d allocate to it now… and half in a few months or when you see a dip.

You can also consider investing smaller amounts over a longer period of time. This is what we call “legging in” or “dollar-cost averaging.”

None of us can time the market with 100% accuracy. And none of us can get every investment right.

But this approach can help you protect your nest egg if one of your investments doesn’t work out.



Nomi Prins
Editor, Inside Wall Street with Nomi Prins