Did you hear the story about a big AI-focused hedge fund that collapsed? Once you get past the schadenfreude, there’s two very important risk management lessons to learn.
If you missed it, here goes: A young 25-year old from Germany, Leopold Aschenbrenner, is a brilliant math and economics student who graduated at the top of his class. Not long after graduating, he joined OpenAI but was soon booted from the company. Leopold saw an opportunity in the AI boom, so he raised a slew of capital to get his hedge fund off the ground.
Without much resistance, the AI companies that Leopold invested in kept pushing higher over the past couple of years. The value of his fund rose accordingly (to $45 billion). But here’s the catch: He achieved spectacular gains using massive leverage (borrowing heavily to buy his positions).
While you can achieve nice returns with leverage, there is always a chance for disaster. That happened last week. AI stocks dropped, and Goldman Sachs (one of the fund’s larger lenders) demanded payback on some of its loans. The wheels quickly came off the bus.
Leopold built the fund on an unwavering belief in the AI revolution. And as we all know, hope is not a strategy. He ended up selling most of his positions to the Citadel hedge fund for a fraction of its value. His fund collapsed in just four days.
2 risk management lessons from Leopold Aschenbrenner
This story serves as a reminder to always practice risk management. Two in particular stand out.
Lesson 1: Do not buy on margin
Leopold completely lost control of his fund, and he did not sell when he wanted to. Instead, he was forced to liquidate to meet margin calls.
Lesson 2: Keep your risk as small as possible
Manage your risk like a baseball manager does in a ball game. There will be losses if you’re in this game for the long-term. Just keep them small and manageable by risking only what you can afford to lose.
And by the way, a hedge fund manager has zero excuses when it comes to risk management. If you’re a hedge fund manager, the first person you hire is a risk manager. And then you commit to always listening to them when they tell you to slow down, take down positions, or sell.
Who knows where Leopold goes from here, but clearly he lost this game. The market makers who liquidated him won again.
This free guide will teach you how.
