≈ What is a good investment? ≈
“What is a good investment?”
“It’s an investment that makes you money with no risk.”, many would say.
Robert Rubin served as the 70th U.S. Secretary of the Treasury. Before that, he spent 26 years at Goldman Sachs. His field of expertise? Risk arbitrage, a strategy that involves buying securities that are subject to a major event (merger or bankruptcy, e.g.). Highly complicated but highly profitable.
In 1967, Becton Dickinson was about to acquire Univis. In an event like this, you can’t just make one single decision ex ante and wait for the ex post results. The odds changed constantly, which forced Robert and his team to recalculate the probabilities and decide whether to increase the position, decrease it or exit.
After all the calculations and deliberations, the investment thesis was solid:
- Long 33,233 shares of Univis @ $30.28 (average).
- Short 19,800 shares of Becton Dickinson @ $55.
- Expected profit: $125,000 (not too shabby in 1967).
The merger fell apart months later. Univis fell way down to $18 while Becton shot up to $64. Total loss: $675,000.
Rubin explained: “Even a large and painful loss doesn’t mean that we had misjudged anything. […] The essence of arbitrage is that if you calculate the odds correctly, you will make money on the majority of deals and on the sum total of all your deals. […] To an outsider, our business might have looked like gambling. […] It was an investment business built on careful analysis, disciplined judgments […] and the law of averages.”
Their optimal rate of failure wasn’t zero but 1 to 7. Less than that meant they were not taking risks.
So, “What is a good investment?”
Real traders and investors don’t know what lies ahead. The ex post world is yet to be explored. The complex, ambiguous and uncertain world of the ex ante is where they live.
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