Thursday, 17 May 2012

Book Review - When Genius Failed: The Rise and Fall of Long Term Capital Management

When Genius Failed: The Rise and Fall of Long Term Capital Management When Genius Failed is a comprehensive look at the amazing rise and fall of one of the most noted and hyped hedge funds of all time.  This book severs as a warning to all investors about the risks of leverage and hubris.   I would rate this book 4.5 / 5.0.

Long Term Capital Management (“LTCM”) was a fund set up by the superstars of finance including the rainmakers from Salomon Brothers (then the premier Wall Street trading firm) as well as stars from academia including Robert Merton and Myron Scholes.   LTCM was considered absolutely foolproof by investors, Wall Street counterparties as well as the fund managers themselves. 

When Genius Failed is broken into two sections: The Rise of Long Term Capital Management and The Fall of Long Term Capital Management which provies an in depth look at the founding, funding, operating and eventually the fall of LTCM.  The book provides a spectacular amount of detail on a range of topics including:

·         The rise of John Merriwether (who famously challenged John Gutfreund to a single hand of Liar’s Poker for $10m as described in Michael Lewis’ Liar’s Poker) and the unlikely team of academics that he hired into Salomon Brothers’ trading floor

·         What a hedge fund is and the prevalence of these at the time LTCM was formed (though the book does not spend too long on pointless filler unlike Liar’s Poker)

·         A basic overview of LTCM’s arbitrage strategies as well as the theoretical basis behind these.  One of the great revelations of the book was how these brilliant minds, who must have known the shortcomings of their models and theories, were lulled into a false sense of security that their models could never fail

·         The inherent secretiveness of LTCM and their ability to play the investment banks off against each other in order to get better terms

·         The greed shown by the managers of the fund which eventually contributed to their own personal downfall and bankruptcy

·         LTCM’s move away from convergence strategies into much more risky areas including merger arbitrage which was well outside the managers experience

·         The collapse of Russia and the total dislodgement of the market for risk including the flight to risk in the market which was catastrophic for LTCM

·         The attempts to re-capitalise and save LTCM and the eventual deal that was pieced together by the banks in order to save the financial system

While this book is not written for
beginners, it is a good primer on the hedge fund industry and basic arbitrage strategies.  It is also a great read for those seeking the story behind one of the biggest hedge fund collapses in history and those looking to apply the lessons learned from the LTCM collapse to ensure it doesn’t happen again.


ü  When Genius Failed does brilliantly what so many other books fail to do.  It provides enough information and background information to ensure that the reader has all the necessary facts and knowledge to appreciate the complexities involved in the situations described though does not provide so much information that the book starts to drag

ü  The reader is treated to an inside view of the mentality of both the managers and staffers at LTCM as well as players at the banks that got burned by LTCM


û  The second half of the book dragged significantly more than the first half.  I don’t view this as detracting too much from the book however as the authors provide a detailed description of all the events that combined to tear LTCM apart


·         This book should be mandatory reading for all those who invest money (especially for those who do it on behalf of others).   It highlights the risks of leverage and also the risks associated with ‘black swan’ events. 

·         It is surprising that with the LTCM message already available before the GFC, that companies, funds and investors continued to be so highly leveraged and invested in areas in which they had no significant expertise

·         This book is written for those who already have an understanding of finance and financial markets.  The strategies and concepts in the book are relatively advanced (though those with a rudimentary knowledge of shares, bonds and other derivatives should have no trouble)

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