About The Time I Started The Best Hedge Fund Ever

First I want to tell you a story about an investment strategy that works great, if you do it right. But, when I tried it, I screwed it up.

This has nothing to do with the investment strategy that I’ll be talking about on June 8 in the webinar with everyone. That one I know works and you can learn more about it here.

But until then, I wanted to tell a few stories about my history of investing.

I’m a quant trader at heart. Meaning: I’ve programmed a lot of software to help me figure out which investment strategies work the best.

I look for patterns in the market that have worked in up markets, down markets, crashes, booms, etc.

The strategy I’ll be showing the people who sign up for my webinar in a few days works very well in all markets. It’s both a quantitative strategy and a strategy that relies heavily on the network of super-investors I’ve built up over 30 years.

But the strategy I tried in 2008 was a day trading strategy and was good for solid daily returns.

I don’t like to recommend those because it requires sitting at the computer all day and being depressed. At least for me.

At the time, I had moved into a new house, the world financial markets were falling apart, and I was scared to death.

I had just raised some money from a friend of mine who ran a hedge fund.

Why did he give me money? Many reasons.

In 2004, I was running my fund of hedge funds and I was one of the seed investors in his hedge fund.

He specialized in the strategy I am going to talk about in a few days. He is brilliant, his fund survived 2008/2009 and he is flourishing now. I still invest with him on many individual deals.

But the good people who stay in your life for years are the ones who, when it’s all added up, help determine whether or not you’ve lived a good life or a bad life.

So I called him and said, I have an idea I’d like to show you.

Later that afternoon I was in his office with his two partners.

I pitched the idea. They said, “We’ll give you X millions of dollars and seed this fund and we’ll own the fund with you 50-50.”

I said, “OK.”

They asked me if I needed an office and a team around me and I said “sure,” but I didn’t really need anybody.

I knew my software would give me signals each day and I just had to trade on them. Then after a few months of track record, we could go out and really raise a lot of money.

This was my plan.

But, as the cliche goes, “men make plans, and God laughs.”

We opened up shop in September 2008, the beginning of the worst seven months in stock market history.

Before I get into what happened, let me tell you the strategy. The strategy works and still does.

INTERNATIONAL ARBITRAGE STRATEGY

A) Find countries that are correlated with each other: For instance, the USA and Canada are correlated because both are North American. And Canada and New Zealand are correlated because they are both commodity-dependent economies. And New Zealand and Japan are correlated because both are Asian.

I found about 50 country “pairs” like this.

B) At end of day, find which correlations are “out of whack”: If Canada veers away from the USA and is going too much towards being overly correlated with New Zealand (or Brazil) then eventually it will “snap back” to being its normal correlation with the USA and it’s normal correlation with New Zealand. Then I might go long Canada and short New Zealand until they snap back. Because I am long an entire country and short another, and the global markets tend to move together, I do not have any single company risk and I am relatively confident that things will snap together as planned.

It’s a “breathe easy” strategy as I like to call it. Similar to the strategy I outline in my “Altucher Income Advantage” if you are a subscriber to that.

HOW DID THE STRATEGY DO?

Keep in mind that in September 2008 the markets fell apart.

Lehman Brothers collapsed. The entire world economy was being shattered. And the Dow was starting to go down 500 points a day. It was unbelievable what was going on.

And yet, the strategy above did well. I remember it doing about 5% up that month.

I only wish I had followed my own strategy. At the end of the month I was pretty much out of business. Again.

MY MISTAKES:

A) I MESSED WITH THE STRATEGY: I figured: Well, if this works for countries, maybe it works for companies.

And, I was right, it does. United Airlines and American Airlines would correlate well . Ford and GM would correlated well.

I found 100 company pairs like this. And I modeled them out for 15 minute trades going back 30 years.

The lesson is: don’t program a strategy and start trading it the same day.

I had no idea how to handle the single company risk that was happening in the markets starting that month (for instance, GM went on the path to bankruptcy and Ford didn’t).

If you have a strategy that works, stick to it.

I had a product that I knew was a good international arbitrage fund. Why didn’t I just stick with it? I was greedy.

B) EGO: I wanted to believe that I could keep improving the wheel. Sometimes the wheel is all you need to get around. You don’t need a rocketship to build a solid business.

C) I TOOK INDIVIDUAL STOCK RISK: This was 10 years ago. I had been through the  Internet bust but never really a bust like the one that was about to occur. And I didn’t know the financial industry the way I know it now.

So, like an idiot, I took a bet that the government wouldn’t let Lehman Brothers go out of business.

This had nothing to do with my strategy. It was a complete single-company gamble based on a  government decision.

In other words, two really bad decisions combined to make another really bad decision (an investment).

D) I DIDN’T ACT LIKE A BUSINESSMAN, I ACTED LIKE A DAYTRADER

Day trading is hard. When I day traded, I was in the trenches. It was me versus the world. My brain versus the top brains on the planet. And I wanted to win.

But that’s not how a businessman should think.

A businessman needs to focus on building his business first, dealing well with other people, communicating, managing risk, and being a leader rather than being a cowboy.

I was a psychopathic cowboy. I tried many strategies that month. I wanted to be hero. Not just return 5%.

I didn’t realize that any fund that returned even 1% in September 2008 ended up being a billion dollar fund.

If I just did the one strategy I had set out to do I would’ve been up around 5% and on the way to a billion dollar hedge fund.

Instead I tried to make 100% and ended up down about 20%.

E) COMMUNICATION

I had a business partner. The fund that had given me money.

And even though we had all worked together for years and I had helped them out in many situations, including seeding their fund in 2004, I still had to be professional when there were millions of dollars involved.

There’s no excuse to not being a professional.

If you aren’t a professional, you are an amateur.

I stopped returning calls when I was down. I was too ashamed to admit we were down even though the basic strategy (international arbitrage) was up almost every day.

Finally, I had to call them and tell them they were down for the month.

I remember it so clearly. The main partner told me on the phone, “Listen. We’re pulling the money and shutting down this fund.”

I didn’t say anything.

“I have to tell you why,” he said, “it’s not because you were down. I could care less about that. It’s because you didn’t return my calls.”

He said, “If you want to stay in this business, you have to return people’s calls and be a professional.”

This was a huge inflection point for me. As I’m sure  it was for  many people who were neck deep in the financial crisis.

So we shut down that fund. And, in fact, the only way I survived the worst financial period in history was by doing the strategy I’m going to describe to you on June 8th.

AFTERMATH

It took about three years before I spoke again with that fund.

I went over there and had lunch. It was a reunion. We were able to laugh about it and talk over old times.

We finally started doing deals together again. Not my strategy, but theirs, which is strongly connected with the strategy I’m recommending on June 8th to those that have signed up for the webinar.

Later today I’m playing ping pong with one of the partners of that fund. We still do deals together. And I always make sure we have fun.

I can’t wait to tell you these stories. Not because it will help anyone, but because I just want to get them off of my chest.

The best investment is sleeping soundly at night.

James Altucher

Written By James Altucher

James Altucher has run a nine figure Venture Capital fund, a hedge fund, a fund of hedge funds, and is currently invested in over 30 private angel investments. Some of his bestselling books related to finance include "Trade Like a Hedge Fund" (voted book of the year by "The Stock Trader's Almanac"), "Trade Like Warren...