Lessons on risk management from the collapse of a $9 billion hedge fund

After reading extensively and experiencing various case studies, you'll realize that the pressure for quick success and instant returns in the investment world is structurally inherent, often extremely strong and never disappearing. Many institutions will perpetually repeat the vicious cycle of "anxiety - taking greater risks - temporarily achieving small profits - excessive risk leading to sudden and devastating losses - being forced to start all over again." For example, the pensions of public servants in a certain California county only yield a 5% annual return, while the cost of retiree benefits continues to rise. Everyone wants "both," so managers face immense pressure to invest part of their pensions in hedge funds, where risk assessments are difficult to assess, in hopes of achieving high returns. To allay retirees' anxieties about the safety of their funds, managers promise to closely monitor hedge fund returns every month and immediately prepare to divest if performance underperforms. Of course, hedge funds, eager to secure clients' money, initially offer generous promises and sweet talk. Because clients are so closely watching, fund managers have no choice but to sit back and do nothing for months, even two or three years. They are forced to stare at large screens day in day out, desperate for quick success. Within the fund, if a short-term strategy makes a killing, even with significant potential risks, managers face immense pressure to immediately allocate more funds to it, withdrawing some of the funds originally allocated to long-term, stable strategies. The final outcome is a cliché: the short-term strategy suddenly fails, resulting in huge losses. Without even time to communicate with clients, the fund suddenly goes bankrupt. Pension funds, originally intended to generate exceptional returns, find themselves suffering heavy losses, ultimately becoming the source of exceptional returns for others. Retired elderly people are seeing their benefits drastically reduced, and everyone is crying foul.

As long as enough people gain short-term benefits or indulge in the illusion of benefits, and not too many people suffer losses for the time being, the public can completely ignore the common sense of 1+1=2 for a long time and confidently fabricate a self-consistent theory for the asset bubble.

Avoiding losses, or preventing people from realizing they've already suffered losses, is crucial. Therefore, with each new round of venture capital, they strive to create the illusion of rising valuations, desperately trying to avoid a down round. Consequently, Wall Street brokers constantly use new debt to repay old debt, or layer upon layer of debt and transfer it to distant, uninformed third parties. Otherwise, once a down round occurs, or a debt default occurs, and people are awakened from the illusion, it will be difficult to reverse the situation.

"People want what they can't have. People want what others want. People want what only a few can have."

If you respect and adapt to such human nature, your life will be better.

Building a system for compounding profits through the introduction and implementation of forcing functions is far more important than impulsive actions. We need to consider whether our daily information environment consistently focuses our attention on building sustainable advantages, or whether it constantly leads us into the trap of cheap dopamine and whining. Does our information environment help us quickly identify and filter risks, or does it constantly push us into seemingly profitable but devastating bubbles and scams?

There are two key factors to consider when determining whether you're growing: First, will what you're doing now be reusable and continue to benefit you ten or twenty years from now? If not, you're probably just struggling, not growing. Second, does what you're doing now carry the risk of ruin? If so, even if there are short-term gains, it's a gamble that won't lead to long-term growth. Master these two factors and give them time. Over five years or more, you'll be surprised at the extent of your growth.

Over time, it's easy to see the flaws in most people's behavior: First, they're haphazardly trying things here and there, lacking the patience to accumulate success. They lack a clear advantage in any competition. Naturally, their daily lives become extremely tiring and exhausting. Second, their impatience for success can easily lead them to blind their minds, often exposing themselves to seemingly low-probability but potentially catastrophic risks. A single setback wipes out decades of accumulated experience, forcing them to start from scratch.

If a company owes $11 billion in debt with an average interest rate over 10%, it's a true subprime mortgage. If the debt continues to grow, it's a very dangerous sign.