Lessons from Failure: Long Term Capital Management

The following post is an excerpt adapted from a letter sent to my financial advisory clients in November 2023.


When Genius Failed

Twenty-five years ago, following four years of rocketing success, Long Term Capital Management (“LTCM”), one of the largest investment hedge funds in the world, collapsed. This failure threatened to pull down the broader financial system and prompted a bailout orchestrated by the Federal Reserve with funds from a consortium of large Wall Street banks. These events are wonderfully chronicled in Roger Lowenstein’s When Genius Failed, so named because of the star-studded management roster at LTCM.

The LTCM meltdown was quickly overshadowed by the dot com stock market bust, Enron and other corporate scandals, as well as the exhausting 2000-2002 bear market. The LTCM failure had become a distant memory, when, only 10 years later, the 2008 Global Financial Crisis hit, along with its own Federal Reserve coordinated bailout.

For investors focused on building and preserving wealth, the lessons of LTCM are worth studying. While the specifics of LTCM’s strategies get fairly deep into financial mechanics (this piece from PRIM – Professional Risk Managers Association June 2021 Long-Term Capital Management offers an overview), a key lesson from the LTCM crisis is their failure of risk management.

How did the geniuses fail? They concentrated too hard. Being overly concentrated in the type of investments they made and applying high degrees of leverage combined to send LTCM to the bottom and explode like a depth charge.


Risk: Market vs. Company-Specific

In building portfolios, there are many risk management considerations. One key step is deliberately working to diversify away from company-specific risk (i.e., the risk of any one company having serious performance issues or being subject to an external event that could lead to a permanent destruction of capital). Concentration can work to build wealth (although this is certainly no guarantee; for a multitude of reasons, many great ideas or great companies simply fail to continue to perform at market levels), but history is littered with examples of over concentration being a poor strategy for preserving wealth!

However, it’s not just about risk, as diversification can also enhance long-term returns. In fact, diversifying and expanding your investment footprint can help capture the market’s star performers.

I talked more about the concept of company-specific risk (non-systematic) vs. market risk (systematic) in my recent “Money Matters” radio episode, and the benefits of diversification in this piece Investment Diversification: Age-Old Wisdom.


Markets & Economy

Headline stock market returns have been solid through third quarter, but the returns were driven by an extremely narrow cluster of technology stocks, which look expensive by most analysts’ measures. Stripping out the returns of the few tech leaders shows a largely flat broader stock market. I discuss this phenomenon, market volatility, the economy, and how to evaluate your portfolio returns in October’s Money Matters radio segment.

For a much deeper look into the economy and investment landscape, I encourage you to watch my recent webinar with market strategists from Vanguard, one of the largest investment firms in the world. Ryan Zalla, PhD, John Lord, CFA, Asawari Sathe, Senior Economist, and I have a great discussion on what’s driving markets and where potential investment opportunities lie. 

A few highlights of the webinar:

  • An economic “soft landing” is possible (or may already be happening)

  • Bonds are offering more income than they have in the past 15 years

  • Dividends are rich and earnings per share are cheap to buy abroad

  • Smaller companies with reasonable valuations appear to offer strong growth potential.

You can access the webinar through this link: Vanguard Webinar

It should be noted that market strategists from Vanguard discuss their own study regarding the benefits of working with a financial advisor. This study has significant limitations that should be considered. Please click here for additional information about these statements.

As a seasonal treat, Brian Levitt, Global Market Strategist for Invesco, offers us “Ten Reasons for Investors to be Thankful This Thanksgiving.”


The Giving Season

Philanthropy and charitable giving are important financial goals for many of our clients, and these topics come to mind this time of year. We are always happy to discuss how to maximize your charitable giving—it’s rarely with a checkbook or credit card! Please put down the pen, pick up the phone, and give us a call, so we can talk about optimizing your giving strategies. I’ve also curated several resources on the topic for you:


Talking Turkey

As part of our effort to help with your planning and to minimize stress and uncertainty in your life, we share this critical, “Am I Ready for Thanksgiving” flowchart:


To see full size flowchart, click here: fpPathfinder – “Am I Ready for Thanksgiving”

We are thankful for the opportunity to serve you, and those close to you. As always, please let us know if you have any questions.

Thank you,

Scott