If you learn from your mistakes, the global economic crisis in 2008-2009 should have made me a very smart person.
I was managing a hedge fund that invested mostly in Russian stocks – at a time when the Russian stock market fell by 80 percent within seven months. The country’s economy and stock market were (and are) highly dependent on the price of oil and other commodities, which fell sharply. And the flight from risky assets everywhere affected Russia more than any other big country.
US$50 million isn’t that much by hedge fund standards. Just yesterday alone, one big hedge fund company, Pershing Square Capital Management, lost US$700 million on one bad stock bet. But it feels like a lot when it’s your responsibility.
Some of the most important expensive lessons are these…
– Count to 10… and do it again: Some of the worst decisions I made in the midst of falling prices were decisions that I made quickly. Buying a stock when the price ticks up, after instantaneously convincing yourself that the trend is turning (see below) is a terrible idea – unless you’re very lucky. Few split-second decisions – except those to swerve to avoid hitting something large on the road – are good ones. If it’s a smart decision, it will be a smart decision after you count to 10 – and after you count to 10 again.
– Stick with your big picture…: Sometimes, a new development can feel like something big and important that changes everything. The sense that any little piece of information is momentously important is increased when you’re in the midst of a crisis. The price of oil was up yesterday? That changes everything… Buy! Buy! Buy!
Virtually all of the time, these short-term shifts mean nothing. Markets always move, but where they move from day to day doesn’t matter much. As prices were falling in 2008, it was easy to interpret any small signal as the start of a turnaround. And I was wrong every time.
– …But be willing and ready to change it when the time comes: As economist John Maynard Keynes is believed to have said, “When my information changes, I alter my conclusions. What do you do, sir?” No trend lasts forever. In 2008-2009, stock prices weren’t going to fall forever.
Eventually, the facts change, and lots of small pieces of information add up to something important. Then, it’s time to change your mind.
In Russia, the collapse eventually played itself out, and the stock market rebounded nearly 250 percent in a matter of months.
– Make sure your assets are hedged and diversified. This might sound obvious, but it’s not as straightforward as it sounds. When you “hedge” it means you protect yourself against something changing that could hurt you… after all, a hedge fund is a type of investment vehicle that’s supposed to perform better than the market overall because it’s hedged.
With a portfolio of stocks, that means that you might buy an asset that is uncorrelated to the rest of your portfolio – so that you own something that is more likely to increase in value if everything else falls.
Another way to hedge is to diversify your portfolio. And from the perspective of “personal equity” you can hedge yourself by making sure that you don’t have all of your assets, as well as your professional prospects, in the same market, country and currency.
When almost all markets in the world are falling at the same time, diversification doesn’t help. And when this happens, correlations between markets go up.
One way to hedge in this case is to sell some markets short, which is a way to profit from falling (rather than rising) prices.
Just because a lesson is learned the hard way doesn’t mean it’s learned for good – or that you won’t forget it. Even the best investors can’t always prevent their emotions from getting in the way of their decisions. But taking note of what you learn – I hope – might mean that your errors won’t be as costly the next time.