Jim Rogers commented on my article, “Where Were the Drama Pundits [Whitney, Taleb, and Gasparino] When it Mattered?” at Wall Street Pit.
I doubt anyone reading this needs the following recap, but just in case here it is. Jim’s words carry a lot of weight in this business. Everyone I know (well, not Meredith Whitney, but I don’t know her) listens up when Rogers says he is short a stock or that a company will go bankrupt. Jim Rogers has a brilliant and credible track record, backs his opinions with facts, tells you how it worked out in the end, and has his own money riding on the outcome. His books on his travels are filled with observations about economies, societies, governments, and life. They should be required reading in every business school.
Rogers writes that he never received a death threat even though he regularly appears on business news programs stating he is short a stock or that a company is likely to go bankrupt.” *
He also noted I had written: “’$20 billion’ referred to a ‘notional’ amount of derivatives that produced between $250 to $500 million in gains, it raises further strategy questions.” Rogers weighed in: “Strategy questions? It raises more questions than that. A ‘$250 to $500 million’ gain on $20 billion is peanuts — 1 or 2%??”
Jim Rogers is absolutely right; I didn’t go far enough. He raises a legitimate point.
The fund in question is Universa’s “black swan” fund. The purported strategy was to buy out-of-the-money put options on stocks and broad market indices and hedge tail risk for clients (note that this is not a hyper-inflation fund or one of the other funds that may be managed by Universa). What are the details of the derivatives that required $20 billion in notional to produce so few gains?
It is unlikely Universa could justify using the over-the-counter market, which would have involved trading with the banks and former investment banks, because the strategy would also have created large counterparty credit risk, which would have to be hedged. That would seem inconsistent with a “black swan” fund.
If the strategy included shorting certain stocks, it can sometimes produce large losses, so that is inconsistent with the idea of the potential of only losing small amounts of money while awaiting a big payday, as a “black swan” fund is supposed to do. There can be unanticipated events resulting in a market upturn, and a short sale would create enormous losses, not get rid of tail risk for losses.
Perhaps credit derivatives were involved, but one would have to hedge the counterparty risk, and again, why the large notional amount with so few gains?
Jim Rogers is right to take me to task for not raising more issues about a “black swan” fund that reportedly had only $300 million under management in January 2007, used derivatives with a notional amount of $20 billion, and produced gains on that notional amount of only $250 million to $500 million. There might be a reasonable explanation, and it seems I am not alone in wondering what that explanation could be.
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Janet Tavakoli’s book on the causes of the global financial meltdown and how to fix it is: Dear Mr. Buffett: What An Investor Learns 1,269 Miles From Wall Street (Wiley, 2009).
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