There aren’t many things we’d want to learn from Colonel Gaddafi. You wouldn’t want tips on personal appearance, for certain. The Libyan ruler usually appears with hair that doesn’t seem to have been combed since 1986.
Nor would we want many lessons on how to run a country, human rights, or indeed staying on good terms with your neighbours. There is one thing we could learn, however: how to avoid getting eaten alive by the sharks of the financial markets.
Amid the collapse of the Libyan regime, details have been steadily emerging about the management of the country’s sovereign wealth fund. With $64bn in assets, the Libyan Investment Authority was a target for just about every investment banker and hedge-fund manager in the world.
It appears to have been a very soft touch. If you knew the right people, and where to take them out to dinner, the Libyans would put their money into just about any scheme, no matter how crackpot it might be. Ordinary considerations, such as the fees that had to be paid, or the likely level of investment returns, don’t appear to have played any part in their decision-making process. In one example, the fund paid $27m in fees for the honour of investing in a hedge fund called Permal, which went on to lose 40% of its value between January 2009 and September 2010, according to a report in The New York Times. That was just one example among many.
Admittedly, there is some poetic justice in this. The Libyan government largely robbed the money from its own people. If it got ripped off in turn by a bunch of smartly suited charlatans from the financial markets, it is hard to feel much sympathy. They’d only have spent the money on guns and mercenaries. Still, the serial blundering of the fund is a useful guide to the pitfalls of the markets. There is plenty to learn from its mistakes.
Firstly, watch the fees. Permal was just one example, although an extreme one. The Libyans also paid out $5m in fees to the Swiss firm Notz Stucki on a $300m investment. They proceeded to lose 18% of that money. The leaked report showed a series of very expensive investments, none of which managed to produce any meaningful returns over and above what you might make simply by picking stocks randomly.
“Very high fees for no value”, the report concluded – somewhat despairingly – in a review of its investments. It is very hard to beat the market. It is even harder to find someone who can beat the market for you, and can do so without charging you so much for the privilege that you no longer come out ahead. The best thing you can do is keep the fees as low as possible. Just doing that should make sure you stay ahead of the pack.
Secondly, steer clear of structured products. There has been a boom in creating very complex instruments that might or might not pay out, depending on a series of events. So if the oil price goes up by 30% and the FTSE down by 3% and the yen appreciates by 10%, you get back 15% at the end of the year. Or not, depending on what it says in clause 58 of the contract. Complex structured products are invariably a bad deal. If you think the markets are going up, buy shares. If not, stay in cash. That is all the structure you really need.
Thirdly, most hedge funds don’t beat the market. The Libyans turned out to have been suckers for the fast-talking hedge-fund salesmen of Mayfair and Zurich. In total, the Libyans invested $4.5bn in hedge funds, according to summaries of the leaked documents. A few of those made money for them, but most didn’t. In some cases the Investment Authority started asking for the fees to be returned. It should have known better all along. There are a few hedge funds that are worth the 2% management fee they typically charge, as well as the 20% performance fee. But they are very rare. The vast majority charge a lot of money for mediocre performance.
Fourthly, don’t diversify too much. The Libyans were investing all over the place. They had dozens of equity holdings, investments with hedge funds, a huge portfolio of bonds and commodities, and a lot of cash parked at the bank. It was a mess. Sure, you get some protection by investing in a range of different assets. But beyond a certain point you are just guaranteeing that you never make money because when one of your investments goes up, another one will go down.
Finally, never trust an investment banker. The Libyans had a naïve faith that the banks they were dealing with had their interests in mind, rather than their own. The fund was offered options over preferred shares in Goldman Sachs at one point, as a part of a deal to try and recoup losses it had suffered. Société Générale designed a $1bn bet on its own shares for the fund. Needless to say, it was never very likely that any of those deals would end happily. So treat any deal offered to you by an investment bank with extreme caution. If in doubt, turn it down.
These simple principles should make you a better investor than the Libyans.