Risky Business (Part 2)

What can MF Global teach us about risk management?

Investment is most successful when it is most businesslike, Benjamin Graham says. And one of the most critical business issues is who you can trust. In any business, you have to trust people to take payments, to issue checks, to manage your property without your constantly looking over their shoulders. It’s one reason that companies in developing markets tend to be staffed disproportionately by the owners’ family members.

The same holds true with investing. If you have someone managing your money, do you know that person? Are they clear regarding their investment approach, methods, and controls? Do they have adequate insurance? The same questions you might ask of a contractor working on improvements to your home are also reasonable when you evaluate a money manager.

By many indications, MF Global didn’t abide by these basic tenets. Management took massive risks with shareholder and bondholder money. They did it by purchasing bonds issued by troubled European countries, borrowing funds against the firm’s own credit standing. The bet illustrates a classic agency problem: if the trade had worked it would have juiced earnings, boosting MF Global’s stock price, and massively enriching the CEO via stock options. But when things went south it was the equity and bond investors who lost out.

Over the years Wall Street has become more about leveraging returns on its own capital than about caring for clients. MF Global illustrates how important it is to know your manager. Character counts.

Douglas R. Tengdin, CFA
Chief Investment Officer
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