The collapse of John Meriwether's first hedge fund, Long Term Capital Management, precipitated a global panic in 1998 and necessitated a rescue by Wall Street's biggest banks, orchestrated by the U.S. Treasury and the Federal Reserve. Despite being staffed by Nobel Prize winners in economics, the best minds on Wall Street were caught flat-footed by bond defaults in Russia and ended up becoming a morality tale for modern finance.
Of course, no one ended up paying much attention to the morality tale -- Wall Street just continued doing what it does best -- finding ever new and more complicated ways to gamble. John Meriwether even started up a second fund, the eponymous JWM Partners, in 1999. But that venture, too, proved not to be much of a long-term investment -- Meriwether was forced to close it in July 2009 after massive losses.
But Meriwether is undaunted. Now comes the news, from the Financial Times, that Meriwether is starting a third fund, just three months after he closed his last fund. And he doesn't appear to have learned any news tricks:
The fund is expected use the same strategy as both LTCM and JWM to make money: so-called relative value arbitrage, a quantitative investment strategy Mr Meriwether pioneered when he led the hugely successful bond arbitrage group at Salomon Brothers in the 1980s.
The strategy, described by the Nobel Prize-winning economist Myron Scholes as being akin to a giant vacuum cleaner "sucking up nickels from all over the world," can be highly successful in periods following market dislocations.
Relative value trades profit by betting on unusual pricing relationships between securities, anticipating a return to an historically modeled "normal" state between them.
Traders say the strategy has the potential to deliver huge returns in the current market, with many banks' proprietary trading desks having scaled back their operations and far fewer hedge funds in existence.
There's another morality tale embedded in this story, and it's not a very pretty one. People like John Meriwether helped create the current "market dislocations," and now people like John Meriwether get to profit from them. The rest of us just get burned.