Don’t Do This! World-Class Investing Mistakes

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Emerging market stocks are having a devil of a time fighting the headwinds from the tariff wars—both implemented and threatened—that have sent EM currencies lower and scared the stuffing out of investors.

The portfolio of Cabot Global Stocks Explorer (formerly Cabot Emerging Markets Investor), is more than half allocated to cash right now, and may get even heavier into cash before investors feel ready to start buying again. Being heavily in cash allows my subscribers to read the headlines with equanimity, but it makes it hard to recommend new stocks with any confidence.

All I can say is that our defensive strategy (and the declines in the stock of some very strong, very profitable companies) will have us ideally positioned to scoop up some big bargain stocks when the market turns up again.

In light of recent market fluctuations, I thought it might help pass the time if I’d share a few tales of greed, bad behavior, and just plain investing mistakes that have popped up in the financial press over the years. There have been plenty of financial professionals who have made some colossal investing mistakes (some of them criminal) over the years, and I think it makes for fun reading.

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Note that I’m leaving out plenty of stories of pyramid schemes and outright fraud, preferring ones without hardened criminals at their heart. Think of them as “Shark Week” or “Storm Stories” for investors.

Not-So-Honest Investing Mistakes

  • • Kent Ahrens was a securities trader for First Capital Strategists, a firm that had been around since 1980, but only registered with the SEC as a registered investment advisor in 1988. Mr. Ahrens, for reasons known only to himself, decided to make some unauthorized trades on behalf of First Capital’s Common Fund, a fund that consolidated holdings for a group of college endowments. After losing $137.6 million for the Common Fund, Mr. Ahrens pleaded guilty to one count of fraud, paid a fine, and agreed to be permanently barred from ever handling anyone else’s money. That seems fair.
  • • In 1995, Barings Bank — a venerable institution that had financed the Louisiana Purchase and the Erie Canal and was Queen Elizabeth’s personal bank — was declared bankrupt and was bought by the Dutch bank ING for one British pound.  This ancient institution, founded in 1762, was wiped out by the unauthorized trading activities of one 28-year-old man named Nick Leeson. Leeson was a young star at Barings, in charge of the bank’s Singapore securities office. His real job was to execute trades for other departments and clients of Barings, and to make tiny arbitrage profits by exploiting differences in Nikkei futures trading on different exchanges. With no supervision, Leeson soon moved into the immensely risky business of trading futures on the Nikkei 225 stock index and Japanese government bonds. After some initial bad luck, he kept raising his bets, hoping to cover his losses.  He managed to conceal those losses until they reached about $1.4 billion, at which point Barings didn’t have enough money left to meet a margin call and was declared bankrupt. Mr. Leeson had a number of years in a Singapore prison to think about where he’d strayed from the straight path.

Of course it doesn’t take criminal behavior to bring about disaster; in the computer age there have been lots of honest investing mistakes, instances of what computer geeks call “fat fingering” the trading keyboard, that have had dire results.

Honest Investing Mistakes

  • • In 2005, a lowly computer operator at Japanese securities giant Mizuho Securities made a little mistake. He was supposed to sell one share of stock from the company’s holdings in J-Com, a manpower recruitment firm, for 610,000 yen.  Instead, in one of those “oops!” moments that could happen to any of us, he sold 610,000 shares of J-Com for one yen apiece. That was, unfortunately, about 40 times more J-Com stock than Mizuho owned at the time. The firm tried to cancel the order within two minutes, but the Tokyo Stock Exchange blocked the attempt.  The cost to Mizuho of having to buy enough stock to cover the sale is said to have completely wiped out the company’s profit for three months. It also resulted in the resignation of the Chairman of the Tokyo Stock Exchange.
  • (It’s a nice footnote to the J-Com story that an unemployed freelance trader who bought a ton of the mispriced stock for one yen apiece wound up with a profit of about 2 billion yen (about $18 million) after the dust settled. Even financial disasters can sometimes rain gold down on those who least expect it.)
  • • Just one month later, on the first trading day of 2006, an employee at the investment bank Nikko Citigroup was trying to buy two shares of Nippon Paper for his private portfolio. (Some Japanese equities are very expensive, and Nippon was trading at about 510,000 yen a share)  He followed all of his employer’s rules and put the order through Nikko’s own trading department…with one small error. You guessed it: his order was put through for 2,000 shares. The compliance department apparently failed to notice that the order (worth about $10 million) was more than 74 times what the employee had in his account. This one took months to iron out, but there were no high-level resignations.
  • • In early 2008, Jerome Kerviel was a mid-level nobody with a middling education and a routine job making hedging trades for French bank Societe Generale. But he became an instant celebrity when his unauthorized trading of European stock futures resulted in losses of $7.2 billion as he tried to cover up one bad trade with another. M. Kerviel’s actions led to a dip in European markets in January 2008 as Societe Generale unwound his losing positions. (I think his losses are still the record for rogue traders, which is saying something.)
  • • More recently, Knight Capital Group came close to bankruptcy in 2012 when a computer error made a trade that couldn’t be undone.
  • • And in October 2014, an anonymous trader entered an over-the-counter trade for 42 stocks valued at more than $600 billion, then quickly cancelled it. The trader “fat-fingered” the trade, which was for an amount larger than the GDP of Sweden and included a buy of 1.96 billion shares of Toyota (TM) for the sum on 12.7 trillion yen.
  • • And most recently, South Korea’s biggest pension fund, which was trading stocks through Samsung Securites, made a fat-finger error that suddenly issued 2.8 billion shares to employees. Samsung was supposed to be paying dividends worth 2.8 billion won to employees under a stock ownership plan. The error was discovered quickly, but some opportunistic employees had already sold off their mistakenly issued shares. If you’re going to benefit from a mistake, it’s best to be quick about it.

If these tales of financial disaster are helping you to put the current market rumblings in perspective, you can find lots more on the Web. Just Google Joseph Jett and Kidder Peabody, Toshihide Iguchi and Daiwa Bank, and Robert Citron and Orange County, California. You’ll find links to many more.

Or if you’re in the mood for even bigger financial disaster stories involving speculation and gullibility, you might check out the Tulip Bulb Mania (crashed in 1637), the South Sea Bubble (crashed in 1720), the Mississippi Bubble (crashed in 1721), the Florida Real Estate Bubble (crashed in the late 1920s), the Nikkei Bubble (crashed in 1989), the Tech Bubble (crashed in 2000) or the Real Estate Bubble (crashed in 2008).

All of these Bubble stories teach the same lesson, but it seems to be one that every new generation of investors has to learn first hand. That is: if it seems too good to be true, it probably is. Or, to put it another way: crashes always occur; but they occur only when a majority of investors believe that a market crash is impossible and that it’s really different this time.

But as the philosophers say, every dog has his day, and the losses that emerging markets are enduring now will eventually turn around. And I’ll be ready.

Timothy Lutts

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