Privatising Profits, Socialising Blame

The recent roller-coaster ride in South Korea's KOSPI has been quite something. After a strong rally earlier in the year, the market experienced a sharp reversal in July before staging an equally sharp rebound. Majority of opinions focused on elevated margin borrowing and leveraged products, which had amplified the market's movements.

Picture generated by ChatGPT

To be fair, this is not a uniquely Korean phenomenon. We have had seen similar episodes in many markets over the years. When prices rise, investors talk about conviction, opportunity and being right. When prices fall, the discussion can sometimes shift towards interest rates, institutions, short sellers or regulators, to name a “few”.

 

It reminded me of an old phrase: privatising profits, socialising blame.

 

Who owns the decision?

There is nothing wrong with having conviction in an investment, but rather the question is whether the accompanying risks are understood and accepted.

 

One of my principles often advocated is to avoid leverage. Borrowing money to invest does not make the underlying investment better. It simply increases the size of the potential outcome, both up and down.

 

When markets rise, this can make a good decision look even better. When markets fall, however, the losses can become much harder to manage.

 

Framework or speculation?

For investing, we begin with objectives, risk appetite and asset allocation before moving on to individual securities. For trading, there is a defined trading plan, including the entry, exit and acceptable risk. Neither approach inherently requires borrowing money to make the numbers look more exciting.

 

Once leverage and excessive speculation enter the picture, the process can easily be reversed. Instead of asking whether an investment or trade fits the portfolio, the investor or trader starts with a position and then finds reasons to justify it. The larger the position becomes, the greater the temptation to defend it.

 

This is not unique to any particular market or group of investors. Given the right combination of rising prices, easy credit and optimism, it can happen almost anywhere. The problem is that a speculative position does not become a sound investment simply because it has made money. When it eventually goes wrong, blaming the market does not undo the risk that was willingly taken.

 

Conclusion

The KOSPI episode will eventually become another market story. The technology, stocks and headlines will change, but the underlying behaviour will probably remain familiar.

 

For my take, one of the important disciplines in investing and trading is simply to own our decisions. If we are prepared to take credit when we make money, we should also be prepared to accept the lesson when we lose it.

 

A sound methodology cannot prevent every loss. What it can do is reduce the temptation to turn investing into speculation, and ensure that one wrong decision does not have the power to derail the entire journey.

 

The market does not owe us profits, and perhaps that is a good thing.

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