LTCM: Have we learned the lessons from its collapse?

Posted by TEBI on September 6, 2023

LTCM: Have we learned the lessons from its collapse?



“Those who fail to learn from history are doomed to repeat it.” 
— Winston Churchill


One of the most dramatic financial collapses in history happened 25 years ago this month. The demise of the hedge fund Long-Term Capital Management (LTCM) provides important lessons. Yet, as ROBIN POWELL explains, many investors, including professional investors, have yet to learn them.


Long-Term capital Management launched in 1994, the brainchild of a group of prominent academics, including Nobel laureates Myron Scholes and Robert Merton. Between them, they developed sophisticated mathematical models for pricing options and managing risk.

These models were based on historical market behaviour. They were designed to identify arbitrage opportunities and profit from small price discrepancies between various financial instruments.

For a time, LTCM appeared to be very successful. It generated large profits and attracted sizeable investments from institutions and wealthy individuals.

But, in 1998, a series of unforeseen events resulted in huge losses for the fund. LTCM’s positions were highly leveraged — in other words, it had borrowed money to place bets. Those bets turned sour when Russia defaulted on its debt, causing market turmoil. The fund’s high level of borrowing magnified its losses.

LTCM also had liquidity issues, which meant the fund’s managers struggled to exit their positions without incurring even further losses.

Eventually, the crisis threatened not just LTCM’s own survival but also the stability of the global financial system. A consortium of major banks and financial institutions stepped in to bail the fund out. That prevented what could have been a catastrophic chain reaction across the markets.



If you found this article interesting you might want to read the following extract from The Missing Billionaires by Victor Haghani and James White. Victor Haghani was one of the founding parters of LTCM, and in this extract he explains what he learned from the fund’s collapse:

The puzzle of the missing billionaires



This article was written by TEBI’s ROBIN POWELL for Timeline. One of the UK’s most innovative financial technology companies, Timeline provides financial planning software and evidence-based investment solutions to independent financial advisers across the country.



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