The Finance Professor: Manage Risk Like a Pro

Stock quotes in this article: GOOG  

Accept the Risk That You Understand

When it comes to taking risk, you have to accept risk that you understand. For example, as smart as Long-Term Capital Management was, I knew the end was near when the hedge fund started to expand into markets and strategies in which they had little or no experience or knowledge.

I dealt with LTCM from the day it started to operate. At the time, as the head of Global Equity Swaps at Merrill Lynch (MER Quote), I was on the other side of many swap swap trades with LTCM. LTCM wanted to do a "risk arbitrage arbitrage" swap on Tellabs' (TLAB Quote) acquisition of Ciena (CIEN Quote). I knew the deal was going to go bust because for all of LTCM's Nobel Prizes and doctorates, it simply had no idea what it was getting into.

To make a long story short, I refused to do the deal and stood my ground, and two weeks later the Tellabs/Ciena merger was canceled. Several weeks later, LTCM went belly up.

I was able to identify that LTCM did not fully understand the risks involved with the contemplated transaction. As a trader responsible for protecting my employer's capital, I was also acting in a risk-management capacity, because I would have been exposed to credit risk if I'd taken the other side of the swap from LTCM. LTCM did not understand the trade, but I did and thus prevented the fund from making a big mistake.

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At the time of publication, Rothbort was long CAT, GOOG, MW, SO, and SPY and long with calls on MER, although positions can change at any time.

Scott Rothbort has over 20 years of experience in the financial services industry. In 2002, Rothbort founded LakeView Asset Management, LLC, a registered investment advisor based in Millburn, N.J., which offers customized individually managed separate accounts, including proprietary long/short strategies to its high net worth clientele.

Immediately prior to that, Rothbort worked at Merrill Lynch for 10 years, where he was instrumental in building the global equity derivative business and managed the global equity swap business from its inception. Rothbort previously held international assignments in Tokyo, Hong Kong and London while working for Morgan Stanley and County NatWest Securities.

Rothbort holds an MBA in finance and international business from the Stern School of Business of New York University and a BS in economics and accounting from the Wharton School of Business of the University of Pennsylvania. He is a Professor of Finance and the Chief Market Strategist for the Stillman School of Business of Seton Hall University.

For more information about Scott Rothbort and LakeView Asset Management, LLC, visit the company's Web site at www.lakeviewasset.com. Scott appreciates your feedback; click here to send him an email.

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