Curmi & Partners

When Greed turns into Ego

By Somnath Banerjee

This is the second part of eternal sins commentary whilst trading/investing. In the first part I talked about hope. Just like every good investor needs some optimal level of hope, they all need some optimal level of greed and ego too.

Don’t get me wrong, I am not suggesting they are virtues. What I am saying is, without some of it one won’t optimize/maximize returns. It’s a fine line though. Just get an iota more of greed, it turns into ego that may cause serious hurt.

Let me paint a picture. Imagine you have €100 in your bank account. You like company ‘A’ very much, whose stock is trading at €100. You can buy one share of the company (who incidentally only has 100 shares outstanding) and look for it to appreciate. Alternately you go to your bank and say “Hey, I have this great opportunity in buying this undervalued stock of company A. Would you lend me €1000 to buy 10 stocks?” The bank lends you, mostly because they are flushed with deposits. They are like “OK, but you will have to pledge your stocks to us.” Everyone is happy.

Now Stock goes to €120. You are like “See, I told you. I think it will keep going up because stocks don’t go down, especially stock A.” Then you ask the bank to lend you €2000 to buy another 16.67 stocks (that’s 10 times leverage on €200 of unrealized profit in your trade).

Your relationship manager is really happy. She is bringing fees and commissions for the bank and you are a valued customer. But the risk manager of the company is trying to be a party pooper. ‘Of course, stocks A will go up if someone buys 10%-20% of the outstanding in a day. This stock has daily volume of trading like 5 stocks and this guy bought double that amount’. Your relationship manager is fuming and she goes to her boss. The boss looks at the situation and agrees for a compromise (no one wants to rule risk out without the pretense that they have done something).

Relationship manager is asked to check how sound client’s balance sheet is. Eventually she gets new leverage signed off by her boss. The bank holds €3200 worth of stocks and have lent you €3000. Everyone is happy, again.

Now you own 26.67% of the outstanding shares of company A. Rest of the meme trading community is looking at the price action in awe. ‘Ooooo, this must be a great stock’. Then some influencer named ‘deep f*&^%$g value’ or something says, ‘Stock A to the moon’ (I am not making it up, there is an influencer with that handle name and very famous too). Another influencer says ‘Ape bros, diamond hands for stock A’. Suddenly, everyone wants to own stock A but there is no supply. Remember you own c.27% already.

Stock goes to €150. The value of your holding is €4000.

Next day the stock collapses as the CEO of the company A is really excited with the 50% increase in stock prices and want to raise fresh capital at these levels. Stock tanks to €50. Suddenly Bank only has €1,333 worth of collateral and €100 in deposit account. Remember, you owe them €3,000.

Your relationship manager is panicking. ‘Can you please put in another like €1600 with us to maintain the position?’ You sell assets to fulfill margin requirement and buy even more of stock A. ‘How can the share go down? Impossible. It must go back up.’

Sounds familiar. Yes, that’s the gist of Bill Hwang’s Archegos family office story as it unfolded last year. Yes, there are some subtle differences as well like Bill wasn’t taking actual leverage but rather using total return swaps to achieve synthetic leverage and it also helps in keeping assets off balance sheet.

It’s hard to believe that he was buying the concentrated exposure in the undiversified portfolio not without his conviction that there is fundamental value in those stocks (incidentally he was holding 30% to 80% of outstanding shares in the 10 odd Chinese tech stocks). Of course, he is smart enough to know buying many multiples of daily trading volume of the stocks would naturally raise the prices.

It’s difficult to say at what stage greed (excessive leverage) turns into ego (how can this trade go against me). But Bill isn’t the first, won’t be the last. The biggest lesson for any investor is, how to control the greed (manage risk) and ensure it never turns into excessive ego.

Disclaimer

The information presented in this commentary is solely provided for informational purposes and is not to be interpreted as investment advice, or to be used or considered as an offer or a solicitation to sell/buy or subscribe for any financial instruments, nor to constitute any advice or recommendation with respect to such financial instruments. Curmi & Partners Ltd. is a member of the Malta Stock Exchange and is licensed by the MFSA to conduct investment services business.