Lessons from Jim Leitner - Part 1 of 3


In Steve Drobny’s book The Invisible Hands, there’s a wonderfully insightful interview with Jim Leitner, who heads up Falcon Investment Management, and was previously a member of Yale Endowment's Investment Committee. Leitner is an investor who has spent considerable time contemplating the science and art of investing, making money opportunistically across all asset classes, unconstrained, focused on finding the right price and structure, not losing money...and remaining humble (an increasingly rare quality in our industry).

His very clearly articulated thoughts about hedging, risk management, cash, and a number of other topics are profound. Below is Part 1 (please also see Part 2 and Part 3) of a summary of those thoughts. I would highly recommend the reading of the actual chapter in its entirety.

Cash, Opportunity Cost, Liquidity, Derivatives

“Cash always gives the lowest return when modeling on a backward-looking basis.” This is why endowments, etc. tend to hold very little cash, because they construct their portfolio allocations looking backwards, based on historical returns.

But if we construct our portfolio allocations on a forward looking basis, “…cash is the essential asset. When other assets have negative return forecast…there is no reason to not hold a low return cash portfolio.”

Also, by looking backward, we tend to ignore the “inherent opportunity costs associated with a lack of cash…cash affords you flexibility…can allocate that cash when attractive opportunities arise.”

“The correct way to measure the return on cash is more dynamic: cash is bound on the lower side by its actual return, whereas, the upper side possesses an additional element of positive return received from having the ability to take advantage of unique opportunities.”

“Holding cash when markets are cheap is expensive, and holding cash when markets are expensive is cheap.” As equity or other assets get more expensive, it’s important to hold more “cash and cash-like assets” because it decreases the potential for downside volatility.

It’s important to have cash on hand in case assets or securities become cheap because redeeming from existing allocations or selling existing positions takes time.

Hedge funds and some investors that use derivatives and swaps have the ability to gain large notional exposures (via these derivatives) while holding cash in reserve – a nice luxury.