Leverage kills: the Apple edition

Philip Elmer-DeWitt at Fortune has a must-read article up on the rise and fall of Apple analyst-turned money manager Andy Zaky. The story relates how Zaky went from noted Apple ($AAPL) analyst to the manager of an Apple-focused hedge fund and newsletter writer. Not to give away the story but investors who followed Zaky’s advice or invested in his fund have lost a fair bit, sometimes all, of their investment.

There are so many lessons to learn from this story it is hard to know where to begin. Kid Dynamite in a post notes how the Apple crowd became prone to confirmation bias:

Take a bunch of investors who were long AAPL, add in a “guru” who told them that the stock would keep going higher (which, of course, was what they wanted to hear anyway!), throw in a dash of suspect advice like swapping stock for call spreads (increasing leverage and adding time constraints), pile on a heaping dose of GREED, and you get, well disaster.

Felix Salmon at Reuters notes how Zaky would have been better staying in the analysis game as opposed to getting into the advice game. He writes:

Zaky, it’s clear, had much more value to the world of investing when he didn’t have skin in the game than when he did. That might be hard for a former trader like Nassim Taleb to understand, but the fact is that investing creates all manner of psychological feedback loops, which have to be managed with discipline. If you can’t manage those feedback loops, you’ll blow up — but at the same time, absent those feedback loops, you can still be a very perspicacious analyst.

Josh Brown at The Reformed Broker has little sympathy for those who lost money:

This might be the most outrageous thing I’ve ever read. I don’t pity the “limited partners” or the newsletter subscribers at all.  These are no ordinary Muppets – these are SuperMuppets.

I am deliberately not quoting much from the underlying story because I want you to read it in its entirety and see the many ways in which Zaky and maybe more importantly his investors and subscribers erred. I can think of at least three major “investment sins” that they committed. However as the title of this post states the most obvious one is that Zaky, et al. felt the need to leverage up their position in Apple, via the options market.

If we learned nothing from the past decade is that leverage kills. Leverage can kill large institutions like banks and hedge funds and smaller fry like individual investor/traders. The drop in Apple from nearly $700 a share at its high down to $430 today has been painful for a wide range of investors. However no one needed to lose their entire investment through the ill-timed use of leverage.

Items mentioned above:

The rise and fall of Andy Zaky.  (Fortune)

Greed+Confirmation bias=Disaster.  (Kid Dynamite)

When analysts become money managers.  (Felix Salmon)

Are you f%$@ing kidding me?  (The Reformed Broker)

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  • Tadas ViskantaAbnormal Returns has over its seven-year life become a fixture in the financial blogosphere. Over thousands of posts we have striven to bring the best of the financial blogosphere to readers. In that time the idea of a “forecast-free investment blog” remains as useful as it did six years ago. More »

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