A Cautionary Tale from a Hedge Fund Manager Who Lost 99.8% of His Clients’ Money

Last month, newswires reported a sad tale of a hedge fund manager who lost 99.8% of his clients’ money. Starting with US$100 million less than a year ago, that princely sum shrunk to US$200,000 by 20 January this year.

There are snippets from the news article reporting on the harrowing tale which are particularly noteworthy because there are great investing lessons within them.

Never risk your capital on a single roll of a dice

A snippet from the report:

“… he made a series of “aggressive transactions” over the last three weeks to make up for poor returns in December. He said he bet on stock price options, predicated on the broader market rising.”

In essence, majority of his clients’ money was lost when the hedge fund manager tried to make up for his poor performance a couple of months ago by engaging in highly leveraged bets in January. Furthermore, he tried to earn his keep within a very narrow time frame (three weeks).

Point is, it didn’t have to be done that way.

Investing doesn’t have to come down to one or two major bets which you make in your life. Instead, we are free to invest in stages over our lifetime.

If we own a handful of companies, the choice is always available to us to add money to our best business performers.

To keep it even simpler: In our previous article, we have also shown how a modest monthly amount which is put into the SPDR STI ETF (SGX: ES3) – a proxy for the market barometer the Straits Times Index (SGX: ^STI) – may have the potential to provide decent gains to the Foolish investor.

Diversify your portfolio

Foolish investors may have also noted that the losses occurred due to a few concentrated bets. In this case, a comment by investing maestro Warren Buffett comes to mind. The Oracle of Omaha had this to say about Walter Schloss, an investor he particularly admires:

“Walter has diversified enormously, owning well over 100 stocks currently. He knows how to identify securities that sell at considerably less than their value to a private owner. And that’s all he does. He doesn’t worry about whether it it’s January, he doesn’t worry about whether it’s Monday, he doesn’t worry about whether it’s an election year.

He simply says, if a business is worth a dollar and I can buy it for 40 cents, something good may happen to me. And he does it over and over and over again.”

Through Buffett’s words, Schloss’ investing experience highlights the following lesson: By diversifying our holdings, we run less risk in having our portfolio blown up by one or two mistakes.

And crucially, wide diversification need not automatically equate to poor returns.

Take it from the late Schloss. Throughout his investing tenure, he diversified widely but his diversified approach did not come at the cost of his long term returns. According to Buffett’s 1984 article “The Superinvestors of Graham and Doddsville”, Schloss’s WSJ Partnership delivered a breath-taking annualized return of 21.3% over 28 years.

Foolish take away

Investing is not always about making brilliant moves. In fact, Buffett’s illustrious side-kick Charlie Munger believes that it is the other way around. Munger found that Buffett’s long term advantage may have came from first avoiding costly mistakes. He sums it up in this tweet below:

There are better lessons to be learnt from some of the best investors in the world like Buffett, Munger and Schloss. And reversely, as Foolish investors, we may want to take note of the cautionary tales as well.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Chin Hui Leong doesn’t own shares in any companies mentioned.