Meriwether a man for all seasons

 

For two years, John Meriwether has been trying to make amends. Since his Long-Term Capital Management (LTCM) hedge fund fell apart in 1998 - nearly taking the world financial system down with it - Mr Meriwether has been working to pay back the banks that bailed him out and apologise to the people he hurt.

Penance has been painful, and Mr Meriwether said his solace has come in the form of rigorous exercise. Long known as one of Wall Street's better golfers, Mr Meriwether has taken to "power" yoga, a modern variant of the Indian discipline. "I would call it aggressive stretching," he said. It is an apt metaphor for the man: Mr Meriwether bends but does not break. Dressed in a baggy blue sweater, yellow golf shirt and casual slacks, he made it clear during a rare interview that he has lost neither his taste for action, nor his faith in himself. At 53, he is back in the game. LTCM paid back its bankers late last year but even before it had, Mr Meriwether was starting a new hedge fund, JWM Partners - the letters standing for his initials.

He has his regrets. He even flew to Switzerland to express his feelings to the board of UBS, which lost nearly $690 million through its dealings with LTCM, a setback that cost Mathis Cabiallavetta, the Swiss bank's chairman, his job. But as Mr Meriwether sees it, his approach was validated during the market crisis that brought down the fund. Mr Meriwether specialises in bets that relationships between prices of investments will return to historical norms over time.

Using borrowed money to magnify bets, the strategy can spin small price discrepancies into large gains. He said his mistake was he failed to see so many other investors were mimicking his trades. When Russia's default caused the competition to panic, he said he was trampled by the herd. But that very insanity, he said, has given him hope. The irrational divergence in prices that developed in 1998 was the kind of opportunity he relishes. He is clearly sorry he missed his chance. "I would say that August and September 1998 proved to me that there are times when there are great opportunities in relative value trading because of exactly this kind of herd instinct."

Mr Meriwether said only lack of staying power derailed him in 1998: "If we had the capital to maintain ourselves through the storm, those positions would have been quite attractive." Mr Meriwether did not have sufficient capital because, going into the crisis, he thought convergence opportunities were drying up as the market grew more efficient. As a result, LTCM returned $2.7 billion in capital to its investors the previous December. LTCM partners believed they were protected because they had invested in so many different instruments in so many markets. Like a compartmentalised ship, the fund's portfolio was diversified to minimise damage from any particular upset. But there was an unseen iceberg lurking. The various esoteric investments were linked - by the Wall Street herd that had been putting on their versions of LTCM's trades.

In essence, so many investors had pursued similar strategies that seemingly unrelated instruments became linked by common ownership. "The fundamental philosophy was flawed - and that was the concept that diversification mattered," said Mr Eric Rosenfeld, a partner of Mr Meriwether's and a former Harvard Business School professor.

"It worked well in normal times but in the crisis . . . we were left with much more risk than we expected and we didn't have the capital to support those risks." At one time, LTCM had borrowed $50 for each $1 invested. That would have been fine, Mr Rosenfeld says, if its investments had moved independently of each other. "It was a weird crisis," he said. "It wasn't an economic crisis that people think about, that Russia hit and it was a flight to quality. It wasn't a flight to quality. It was a flight out of relative value positions." When the panic hit, however, Mr Meriwether searched for the chips he needed to stay at the table. He came close during the last 10 days of August.

Seeking funds from investors he had paid back the previous December, Mr Meriwether said the early indication was that he might get $1.5 billion in new funds - $500 million of it from one investor. But his faith that his investors would function as his computer models suggested was misplaced. Panic ruled. "I am not so sure we would have said this earlier - there are times when markets can be much more chaotic than one would ever predict, driven in a sense by human behaviour," he said. Simply put, potential bargain-hunters - pension funds and others without the burden of leverage - were more hesitant to return to the game than Mr Meriwether would have been. In the depths of the crisis, for example, he recalls that AAA-rated mortgage bonds that yielded only 35 basis points above Libor when they were issued just weeks before were trading at 120 to 125 points above Libor. By mid-October, Mr Meriwether said a large money manager bought the mortgages and they returned to their former price levels. It was another missed opportunity for LTCM. "Assets got to preposterous levels because institutions were somewhat paralysed," he said.

"I would have ex ante thought, even in the most severe crisis, that intelligent investors - and there are lots of intelligent unleveraged investors who are knowledgeable about an asset class like that - would have made the move much earlier." Now, Mr Meriwether is back making moves but life is far more modest at his offices at One, East Weaver Street, in Greenwich, Connecticut, an upmarket suburb of New York city. JWM is housed in the same building that was once the headquarters of LTCM, although it occupies a sixth of the space.

Mr Meriwether said the LTCM partners and employees lost all their holdings in the fund: $1.9 billion. Mr Meriwether will not discuss his new fund but he is said to have raised about $400 million, some of it from Asia. The partners are scouring the globe for relative-value trades but it seems that the lessons from 1998 are being applied. Stress-testing has grown more rigorous. The assumption now is that all investments could wind up correlated in a short-term panic. They are borrowing less, too: the firm's portfolio was levered 9.5 times. And the net returns have been 6.72 per cent this year through July. This time, Mr Meriwether does not want to stretch too far.