From 1999 to 2019, I managed money for some of the largest hedge funds in the world (Millennium, Brevan Howard, ExodusPoint). During that time, I generated positive returns for 103 consecutive months, which is quite possibly the longest such streak in hedge fund history.
This extraordinary feat was made possible by my strict adherence to three key principles. First, I made sure that I had a method that turns the odds in my favour. Second, I had the discipline to stay with that system in good times, and bad times. Finally, it is vital to play with a bankroll that is large enough to ride out market fluctuations. Lose any one of these three things, and it becomes impossible to beat the market for any length of time.
Have A System: As a professional gambler who accidently landed on Wall Street way back in 1993, I have always had a keen sense of the odds in any game. I played blackjack because it is the only game where a player can gain a provable advantage over the casino. Therefore, from the moment I arrived at Lehman Brothers in 1993, I set about devising an investment method that would provide me with a demonstrable edge in financial markets as well.
Solving the puzzle that was the US mortgage market was an extremely difficult undertaking, one that would take me years to accomplish. Given the sheer number of variables involved, there were times when I didn’t even know where to begin. It took me seven years of constant thought and experimentation to come up with an investment framework that I believed would turn the odds in my favour. My system differed from others in that instead of being at the mercy of large macroeconomic forces, it isolated the major risk factors in any security, and neutralised them one by one. The method was designed to beat the market regardless of whether the economy was on the upswing or in a downturn, interest rates went higher or lower, and whether the housing market was in a bubble or in a crash.
Be Disciplined: A system is useless unless you have the discipline to stick with it. Winning streaks frequently cause investors (and gamblers) to become overconfident, leading them to start increasing their bets. Losing streaks have the opposite effect, causing one to lose faith in their system and sometimes even abandon it. These are both mistakes that eventually lead to ruin.
As with casinos, the key to success in financial markets is equanimity. You cannot allow recent performance, good or bad, to distract you from playing the game according to your chosen method. I had learned the value of being disciplined the hard way, via countless losing streaks in Las Vegas’ casinos.
Consequently, in 20 years of managing money, I have never once deviated from my system. I had to endure markets that were volatile in the extreme, and superiors who were constantly pressuring me to “take more risk”. Yet, throughout my Wall Street career, I have followed one simple goal: play the game well and beat the market, over and over.
Play With A Large Bankroll: Even the greatest investment strategy in the world will go bust without adequate protection against market downturns. Losses are an inescapable part of investing, and a large bankroll is necessary if you wish to live to fight another day. It is, therefore, vital to size your trades appropriately for the amount of capital at your disposal.
In Las Vegas, my bankroll was 400 times my average bet in order to limit my probability of ruin to under 5 percent. I followed that same script on Wall Street. Here too, my trades were sized to lower the likelihood of a catastrophic loss, and not to maximise my pay. To the great frustration of my superiors, I have only ever utilised a small fraction of my risk limit (hedge fund industry’s term for bankroll). While this approach has almost certainly reduced my pay, it has also allowed me to weather numerous crises.
The 2008 financial crisis was a direct result of financial institutions placing bets that were much too large for their bankrolls. At the time of its demise, Lehman Brothers had amassed an astonishing $786 billion worth of assets against a shareholder equity of just $25 billion. In the course of just one year, from 2006 to 2007, the company increased its balance sheet by $188 billion while its equity rose by a mere $3 billion. This was a clear case of an overconfident CEO sharply increasing his bets in the middle of a winning streak. Had he shown a little restraint, his pay may have been lower, but his company would have survived.
Once, upon seeing my rigorous approach to managing money, an investor asked if I was bored of playing the same game for so long. I said: “Would you ask Roger Federer if he is bored of playing in the same 78 by 27 foot rectangle, year after year? An investment strategy is similar to the lines on a tennis court, it merely sets the boundaries of the game. Beyond that, every tennis match is a new challenge and so is every trading day.”
Kamal Gupta is a New York-based engineer-turned-gambler-turned-hedge fund manager. He is the author of Play It Right. Views are personal, and do not represent the stand of this publication.
