It’s been a rough week for investors leveraged to the hilt.

Especially in South Korea, where extreme margin debt is creating a new batch of Squid Game contestants:

More than 360,000 Korean brokerage accounts were forced into liquidation (margin called) this week, per Citi. A reported 62% of those wiped out were under the age of 35.

The next day most of the volatile stocks surrounding this mess ripped higher, which was little consolation to those who were ejected from the game the day before.

The same thing happened to this 25-year-old (apparently Gen Z likes to gamble) hedge fund wunderkind yesterday.

Running a concentrated portfolio of one giant correlated trade (Tech/AI) at 4x leverage - with little to no experience - and possibly $100 billion of notional exposure, is both the most impressive and dumbest investment I’ve ever seen.

Shocker…he blew up.

I can’t imagine the stones it took to even ask investors to fund this wild wager. I wouldn’t have slept a wink all year running a 4x leverage, liquid + concentrated portfolio with other people’s money.

There are lessons to learn from this. I’m not here for the schadenfreude.

The poor guy is getting married this weekend and instead of celebrating with his loved ones, he’s on calls getting fleeced by Ken Griffin (Citadel) and yelled at by his investors and bankers.

Now, don’t feel too sorry for him. I’m sure he’ll bounce back. He did turn ~$1B into 20 billion faster than I’ve ever seen and it sounds like his firm will survive this.

Therefore, the investors that backed him early should still be quite happy. But the LPs that invested recently (including those who reportedly added money just days ago after being told it was a great time to invest) just got smoked / learned a painful lesson.

Leverage has a way of humbling otherwise brilliant men.

The firm Long-Term Capital Management (LTCM) was run by some of the most sophisticated minds on Wall Street. Two of the founders were legit Nobel laureates that created the formula that prices stock options (Black-Scholes-Merton).

I once audited a class taught by Bob Merton.

I could barely understand the words coming out of this man’s mouth. Big brain on Bob. However, investment excellence is more about temperament than intelligence.

LTCM’s strategy was built off their research. The technical explanation their strategy is a bunch of academic gobbledygook. Plenty of confused people invested in LTCM and had no idea what these guys were doing.

Basically their models identified small pricing discrepancies that were likely to reprice higher.

However, penny-sized discrepancies do not produce large returns. But they can if you yolo turbo boost the size of your account.

That worked, until it didn’t. With ungodly amounts of leverage, the trading models were just picking up change in front of a steam roller.

Leverage is also why you’ve never heard of Rick Guerin.

If you have, sorry but a recurring theme of this newsletter is….we need to be reminded more than taught.

Rick Guerin was once considered the third member of the Buffett-Munger trio. Unlike Buffett and Munger, Guerin used substantial margin debt during the 1973–74 bear market.

When stocks collapsed, he received margin calls and was forced to fire-sell his Berkshire Hathaway shares back to Buffett. This is likely when Charlie Munger came up with his famous line on the three things that can ruin a man: Ladies, liquor and leverage.

Now, don’t feel sorry for Rick either. He did just fine over the long-term. He learned excess leverage has a way of turning a temporary decline into a permanent loss.

The problem with today’s leverage-loving, Gen Z gambleholics is they’re combining debt with concentrated portfolios.

They think they’re diversified, but all their stocks trade in unison. And concentration plus leverage is just a train wreck waiting to happen (how many accident metaphors can this guy stuff into one newsletter!?!).

This isn’t an anti-debt rant.

We don’t mind clients using a little portfolio margin for tax-efficiency.

And we love real estate, which is a hard game to play without debt.

But leverage reduces your margin for error. Do enough deals and one or two will eventually go sideways. Plan accordingly.

In other words, don’t put it all on one property and don’t cross-collateralize everything (aka bet the farm), while piling on massive debt. That’s just giving a nervous lender the right to liquidate your best assets in a downturn.

Leverage is a tool, but it pairs poorly with concentration. Combine the two carelessly and a banker decides your fate.

Brad Johnson

Evergreen Capital

P.S. Evergreen’s durable income approach and dividend growth portfolios won’t 20x your capital overnight. But at least its designed to keep you in the game long enough for compounding to work.