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Main Website >>Investment Management / Alternative Investment >>Blog >> What the MF?
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Roger Nusbaum, Chief Investment Officer, YOUR SOURCE FINANCIAL (RIA)

What the MF?
Tuesday, November 01 2011 | 09:09 AM
Roger Nusbaum
Chief Investment Officer, YOUR SOURCE FINANCIAL (RIA)

The big story yesterday was the bankruptcy filing of MF Global. The news angles to this story include Corzine's reputation, possible disruptions in trading, other firms with possible counter party risk to MF, the bonds the company floated during the summer and a bad trade.

There is no shortage of coverage of all aspects of the news but of most interest to me is the trade made by going long, in some form, debt from several of the PIIGS and Belgium. As I write this there appears to be some question as to the leverage to put the trades on but the notional exposure appears to be $6.3 billion.

The reason the trade is interesting is because of the repeat of one of the most common behaviors that does people in time and again which not simply being wrong but being wrong combined with a grossly oversized bet.

This is something I've written about many times over the years and I always include the fact that this will continue to happen forever. I don't know exactly why participants take on deathblow risk with their trades but they do and every so often it ends very loudly as is the case now with MF.

Zooming out a little bit, an actively managed portfolio is a combination of decisions. No one gets every decision correct. No matter the investor, some number of decisions will be incorrect--this is guaranteed. If you know as a fact that some of your decisions will be wrong and there is no escaping this. And if you know ahead of time you will be wrong some times and obviously you can't know ahead of time which decisions will be wrong then the important thing becomes not letting one of these incorrect decisions sink you.

As obvious as this sounds Corzine is evidence that these types of bets still get made. The trade itself could have worked (per one CNBC report the trade might end up working but on someone else's P&L) it just so happens it didn't which didn't have to be a big deal but for the leverage and what appears to be an unwillingness to take a loss earlier on.

Several years ago a reader was kind enough to share his having put 25% of his portfolio into a biotech stock that went on to have deathblow news from the FDA. This anecdote is much closer to the type of damage someone can inflict on themselves as opposed to levering up several times their equity (there are some exceptions) and then wiping out completely.

This type of wipeout is unnecessary but it happens every so often and will happen again. It is a great example to learn from.

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