Big Trouble In Little Cambridge?

Well probably not but Barry has an interesting post about the Harvard Management Company from when Larry Summers was the big man on the campus from 2002.

Apparently a relatively new employee back then expressed concerns for the risks that HMC was taking with derivatives and when she went to Summers with the issue in confidence Jack Meyer fired her. You can read Barry's post and the Boston Globe's coverage for more details.

No doubt there are two sides to the story but there must be a little meat on the bone.

I write often about learning from these pools of capital and this episode (regardless of how true it is or isn't) combined with the results of the fund from 2008 reiterates a great point that is always relevant. A common behavior that repeats over and over is misappropriation of risk and misuse of leverage. Assuming this story about HMC is accurate then that is what it is about.

People have blown themselves up using margin incorrectly or buying 20 call options when they would only buy 100 shares of common, putting 30% into junior mining companies or as one reader shared a couple of years ago having a lot riding on a one drug biotech.

I am at a loss as to how this still happens. There is an element of being too smart for their own good; overconfidence which of course brought down plenty of biggies. LTCM, Amaranth, is this what happened with Victor Niederhoffer, Nassim Taleb has simply awful things to say about Myron Scholes in this regard and there are many other examples. In the future there will be other industry heavyweights that will repeat the behavior.

As true as this is it is avoidable. If you have more than 20% of your portfolio in one sector you are headed toward trouble. Ditto a segment of the market like emerging markets or mining stocks. If you have more than 10% of your portfolio in any one stock (I put way less than 10% into any single stock) you are taking a big risk. If your idea of appropriate leverage means more exposure for the same number of dollars, trouble awaits.

You might laugh at some of this but plenty of people smarter than you and I have fallen prey to these exact problems and I promise you will hear more news like this in the future.

An important building block here is that people who save properly and then simply go along for the ride of the market will have enough when they need it. Once that is understood which may not be easy then issues of the significance the last ten years, whether stocks markets will work the same in the future or how much risk is appropriate can be tackled. The further we get from the building blocks of simple investing the more trouble we get into.