Your knowledge of LTCM

Well, essentially, LTCM's hallmark trade was convergence/arbitrage trades. If they had enough capital to wait it out, they would undoubtedly make some amount of money, but the goal was for the values to converge before the instruments matured. However, they were so levered, they weren't able to stick it out when trades went against them, and had to liquidate. At one point they had off balance sheet positions with a notional value of $1 trillion. Of course, most of these were offsetting and/or closed out positions, but still. In August of 97, they had $127bn in assets on their balance sheet, and only $6.7bn of capital. This is a 19:1 leverage ratio, which actually was still historically low for the fund, which had been as high as 30:1. Banks granted LTCM unbelievably favorable credit terms.

When things went against them, they usually liked to add to their positions, but in 1998 they didn't have anymore capital to invest and were instead forced to exit positions to meet margin calls, it greatly multiplied their losses because their trades tended to be in very illiquid markets (some portion of the basis point spread they attempted to capture was essentially because they were selling liquidity).

Essentially, LTCM didn't fail because they made bad investments, they failed because they were greedy. They returned $2.7bn of capital to outside investors in 1997 so that they could keep returns high, and keep making the managers rich. If they had kept this $2.7bn they would have had enough equity to wait out most of their trades and not have to liquidate. In fact, the amount of capital the banks gave them for the bailout was almost exactly $2.7bn I think.

Hope this helps sum it up. I did a case on this in a class a couple years ago, but unfortunately I don't remember what specific positions they were in (but I do know that the Russian bonds were actually a pretty small exposure for them, and definitely not what made them tank).

I just finished the book When Genius Failed today and they don't explain the exact positions but just stay there were 30,000+ positions and at one point their leverage ratio hit 50 to 1. I would suggest reading the book, its interesting enough to finish and it gets to the point.

russia and emerging markets $430 million directional bond trades $371 million Equity pair trades $286 million Yield curve arbitrage $215 million S+P 500 stocks $203 million Junk bond arbitrage $100 million

Big losses

Swaps $1.6 billion Equity Volatility $1.3 billion

Its on pg 234 of when genius fails, actually had the book at my side as I read your post and had just finished it. They had $3.65 billion put in by all the majors US banks and others except Bear.

It's a good book, read it.

It's amazing how many times meriwether has blown up now.

Haha, yes it is. Guess it just goes to show you that it's all, as they say, who you know as opposed to what.

And thank you matty, that is exactly what I was looking for!

I'm glad JBC reminded everyone about how LTCM forced their investors to take money OUT of the fund...in retrospect it really is hard to feel bad for poor old JM given this stunt, which could have kept them afloat.

I guess I am confused on that point.

Would they have made much more money by getting higher returns on less equity (and thus beating their bogey by more)?? It would seem that if they were able to beat their benchmarks with the extra 2.7 Bn, then it would be close to a wash.

I guess my thought process assumes linearity of return to AUM (which it probably is not), but it has to be close enough, right?

Simply and quickly, when you pour hundreds of millions into obscure areas where pricing is out of whack then the prices should converge to their theoretical values (the difference from which LTCM was exploiting).

They were running out of places to put their money which was dragging the fund return down, and also pushing them into areas where they really had no knowledge or advantage (from "When Genius Failed").