5 Things I Learned About Investing By Trading $1 Billion in Bonds

Photo by Sam valadi / CC BY

My first “real” job was as an Institutional Fixed Income Salesperson on a trading desk in Singapore at one of the world’s top five largest banks. That’s industry speak for “bond dealer.”

Did you see the movie, The Big Short? That’s the world I was immersed in from 2005 to 2009, through the worst of the chaos of the GFC.

When I was hired, I didn’t know what a bond was in the financial sense. I’d dabbled in day trading in equities, and I thought I knew some things, but I really didn’t. By the time all was said and done, I took away not only a good living and a decent level of financial literacy, but more importantly some key lessons on human nature and the madness of markets. I learned just how brutally people behave when there’s money at stake.

Here are the top five things I learned during that season that have most impacted my investing career, things I wish I’d known 11 years ago:

1. Nobody cares about your money unless they care about you.

I saw firsthand how utterly unconcerned most people in the financial services industry were with what happened to the money they passed around. I dealt with commercial banks, investment banks, fund managers, insurance companies and pension funds across five countries, and none of them really cared about whether the bonds they bought were good investments or not.

The internal analysts recommended bonds on arbitrary grounds often as simple as whether the name was famous or a local company, and didn’t care what their balance sheets looked like. The dealers would chisel a few cents when they bought or sold, but had forgotten by happy hour, and didn’t care what happened the next day. The guys at the top certainly did care about something: their bonuses.

The people who are supposed to be keeping your money safe do not care about you. Do not be taken in by the smiling faces on the billboards and TV commercials. They do not care, because they do not know you. YOU care about you, so YOU should take responsibility for keeping your money safe.

2. Nobody understands how everything works, and many people don’t understand how anything works.

The level of financial ignorance in the finance industry was, and still is, horrifying. I was as guilty as anyone. Even into my second year, I would go home having traded a $5 million clip of corporate bonds issued by a company I’d only Googled a few hours earlier, and I still didn’t know how to balance my own cheque book.

I could quote the credit spreads of dozens of sovereign and corporate issued bonds. I could calculate the face value of a 10-year bond to a pretty reasonable estimation in my head (try it, it’s hard). I could give a very smart sounding interpretation of Alan Greenspan’s latest string of intentionally obfuscated nonsense. Behind all that, I couldn’t reconcile my own bank statement and had no idea what my balance sheet was. Neither could most of us, and none of us really cared. But to mere mortals, we sure sounded like we knew how money worked.

The global economy and the markets that run it are massive and complicated beyond measure, a trend that is only accelerating. It is impossible for one person to understand how it all works. It is, unfortunately, possible for a clever person to sound like they understand how it all works during a sales pitch.

I learned from this that the more things a single person purported to be an expert on, and the more complicated they were, the faster I should run for the hills. When investing your capital, get personal advice from multiple sources, and make sure each one is a specialist.

Get a great accountant and lawyer, and listen to them. On the other hand, be very wary of advice from brokers and advisors on any kind of investment product, including real estate. Use them for market data and execution, not investment advice. If they were that smart they’d be making more money as investors themselves.

3. None of us are as dumb as all of us.

My initial ignorance of basic personal finance practices forgiven, one of my redeeming features was a nose for logical inconsistencies. This was very helpful when trying to discern value from price – a concept that is completely, utterly critical to an investor, but remains tragically under emphasized.

The idea of comparable sales in real estate is a classic case. If the house next to yours, identical in every way, sells for $1 million today, then by any rational assessment your house is also priced at $1 million. You will find, however, that these two totally different terms are casually interchanged as the neighbourhood agent knocking on your door explains that your house is valued at $1m. It is not.

In the lead up to the GFC credit markets were underpricing risk, which means they were over pricing risky investments. Did it really make sense to lend money to the government of the Philippines (in US Dollars, which they can’t print) for 10 years at 6 percent, when you could lend it to the US Treasury (which effectively can print dollars via the Fed) for 5.5 percent at the same term, with vastly higher liquidity to boot? Was that fair compensation for the range of things that could go wrong? Bear Stearns and Lehman Brother traded at similar levels, to provide a little context.

When I first saw this, it seemed instinctively wrong. Yet after a couple of years of exposure to it and hearing others speak about it every day as though it were normal, I too accepted it as normal. I was desensitized to it. This happens in all markets, to all participants. Yes, that also includes real estate. Markets that have not seen a major downturn for an extended period are especially prone to it.

The degree to which my thinking was distorted by my environment was shocking. Even though I advised my parents to move their superannuation into cash in mid-2007, I proceeded to contradict myself entirely by taking my own cash and buying into an emerging markets fund pitched by a financial advisor only three months later. The mania surrounding me and momentum were that powerful. Thankfully it wasn’t an enormous sum- it was summarily wiped out over the next 18 months.

Avoid groupthink at all costs. Question and challenge everything. If something that makes no sense to you later begins to make sense, but you can’t actually explain why, then you’ve likely been lulled into groupthink.

4. You are the highest yielding, lowest risk investment in the world. And it’s always a good time to buy.

Around the same time I bought the ill-fated emerging market fund, I was puzzled and irritated because everything seemed expensive.

With the benefit of hindsight, the best investment at the time was cash. Not for the yield (although 5 percent risk-free sounds pretty good today), but for the optionality. Cash at the time seemed unattractive because there was so much hype around other assets. What was being ignored was the option value of cash, and it was only after the meltdown that this option value – the ability to actually buy assets at fire sale prices while the streets ran with blood – was realized.

This dilemma faces us again today. Where do you invest your capital? Cash and bond yields are zero, near zero, or below zero virtually everywhere on the planet. Equities range from expensive to very expensive. Real estate (in Australia, certainly) ranges from not cheap to outrageously expensive depending who you ask. Where do you invest today with comfort?

The answer is surprisingly simple and encouraging. You can invest in yourself.

Wealth comes in many guises beyond your balance sheet. There are seasons when external investment opportunities are plentiful, and there are seasons when they are scarce. When they are scarce, you can always invest in yourself: your health, your knowledge, your networks and relationships, your own sense of purpose and drive.

Sometimes, when investing, there simply is no play to be made – and that’s okay. Investing is more Poker than Chess – You don’t need to make a move every time. We feel we need to be fully invested, all the time, but cash is not trash. At those times focus on investing in yourself and improving your own capacity to create value. It is an investment that is risk-free and yields massive, compounding dividends. It cannot be eroded by inflation, taxed away by the government, wiped out in a market meltdown, or made obsolete by technology.

At best, when the weather turns cold you’ll be smarter, and you’ll have the cash to pounce. At worst, you’ll need to suffer through another dinner table conversation hearing how smart everyone thinks they are in a late stage bull market. Either way, you’ll still be smarter.

5. The means justify the end.

Goal setting is important. Without goals we are corks bobbing in the ocean, entirely at the mercy of chance. With goals we have a ship with sails, a rudder and a map. We are still slaves to fate to a great extent – we can’t control the weather. But we can choose to have at least some influence over the outcome.

Unfortunately goal setting has a dark side, and it is encompassed in a very pithy one liner – the one thing worse than missing your target, is hitting the wrong one.

I am grateful for my time in the world of investment banking. I had a goal in my mind to achieve a certain level of financial freedom before I was thirty, and I hit it. I learned things and met people that opened opportunities later in life that I would have not otherwise had the chance to pursue.

It was only when the shoreline appeared on the horizon that I realized I was headed the wrong way. The year 2008 was in fact the most profitable ever for our team. That was when I decided to stop and change course, even though the weather was amazing.

There is nothing more frustrating than spending large amounts of your time and life force achieving the wrong goal. It’s only when you’ve done it that you understand the price you’ve paid. Have you ever bought an expensive TV set, a car, a vacation home, only to realise after the sugar rush that you’re all the poorer for it and it feels nothing has truly changed?

Financial freedom is the outcome that people recite nine times in ten when I ask them what their investing goals are, but nine times in ten they have no idea what it means beyond “not having to go to work each day”. People want to travel – almost everyone mentions travel in their top three things to do when they’re “free”. They want to spend more time with their family and friends, and most have some sort of hobby or cause they’d like to contribute to.

But all those things combined rarely add up to a full 16 hours per day, 7 days per week. I cannot stress this last point enough: you must identify what it is you want to do. Financial freedom means nothing if you cannot wake up each day to something that you want to do.

I invested at first because I desperately wanted financial freedom. It was a near religious ideal to me that I wanted no matter the cost. The end justified the means, and its value and relevance were self-evident.

Now I invest because I love to solve problems. It’s in my DNA. Fish swim, birds fly, I solve problems. If I’d known that sooner, I wouldn’t have been in such a rush to achieve financial freedom. I could have achieved it just as quickly, maybe quicker, but certainly with more joy if I’d simply focused on what it was that I loved to do, how to become better at it, and how I could do it in a way that created true value.

If you can achieve that, then financial freedom and success become paradoxically less relevant, yet all the more inevitable.

By Aran Dunlop

Aran Dunlop is an ex-international money marker trader who was responsible for billions of dollars of bond trades. He now resides in Florida, and works closely with Steve McKnight, sourcing properties for the Passive Income Fund.