Prologue: Sopwith Asset Management

In 199_, a well-known trader from a leading Wall Street firm decided to strike out on his own. Using a combination of his own money and seed capital from various business contacts, he set up a hedge fund. He recruited an all-star team of traders, technologists, quants, academics, lawyers and administrators to staff his creation, and within a matter of months the fund was up and running. Let’s call it Sopwith Asset Management.

Sopwith’s impressive pedigree meant that it enjoyed an unparalleled reputation in the financial industry. Newspaper articles gushed about its sophisticated investment strategies and cutting-edge financial technology. Academics wrote papers quoting the wisdom of Sopwith’s portfolio managers. Investment bankers wined and dined the staff of the firm, hoping thereby to win a slice of Sopwith’s lucrative trading business. Sopwith alumni were eagerly snapped up by other Wall Street companies. Headhunters called day and night, hoping to lure more employees away.

Helped by this flood of publicity, Sopwith went from strength to strength. It grew in size from a few million dollars under management to a few billion; from a half-dozen employees working out of a nondescript office block in a less-than-fashionable industrial district locale, to fifty power-suited hotshots scattered around the globe.

Sopwith proved to be quite a money-spinner for the people associated with it. Over the years, Sopwith paid tens of millions of dollars in commissions and transaction fees to various investment banks and brokerages. And it paid similarly gargantuan amounts to compliance lawyers, third-party marketers, hardware and software vendors, academic consultants, purveyors of market research, and the like.

But of course it wasn’t Sopwith who was paying any of these costs. No, it was Sopwith’s investors. And why wouldn’t they? After all, they were paying for the privilege of investing with the crème de la crème of the finance industry. A high-profile hedge fund, with vast resources of talent and experience to call upon: the very archetype of the sophisticated financial corporation of the twenty-first century. Aggressively managed, razor-sharp, lean and efficient and hungry. Adept at capturing the smallest and most fleeting of opportunities; adept also at rolling the dice for unimaginable stakes. To invest in Sopwith was to be in elite company.

Alas, the investors were wrong. Beneath the glamour and the glitz, the Emperor had no clothes. Sopwith’s vaunted financial models and analytical technology proved incapable of generating sustainable profits. Good years were followed, inevitably, by bad ones; a monkey flipping a coin could have made as much money as Sopwith did over its lifetime. The cause was not helped by the fact that Sopwith's day-to-day management was a shambles, riven by incompetence, egotism and an utter lack of vision. Slick marketing papered over the cracks for a long time, but it couldn't last. And it didn't.

Ultimately, Sopwith was done in by the tyranny of efficient markets. Sopwith’s investment philosophy was based on the belief that its traders could spot opportunities that others could not; when this turned out not to be the case, there was no backup option, no plan B. As a result, the fund suffered a slow decline into mediocrity, followed by anonymity and then dissolution.

So was Sopwith a failure? Oh no, quite the contrary. Sopwith Asset Management succeeded quite admirably in the task it was designed to do: making its partners and employees immensely rich.

For in addition to the large fees (represented as the “cost of doing business”) that Sopwith’s investors paid to brokerages and vendors and service providers, there were even larger fees paid to Sopwith’s traders and portfolio managers. The incredibly smart people who worked at Sopwith may not have been able to beat the market consistently, but they were very very good at extracting every last penny of fees from their investors. In this respect, at least, they represented the apogee of a fine Wall Street tradition.

I joined Sopwith in 199_, shortly after it was launched. I stayed with it for more years than I care to remember. I saw, at first hand, the firm’s spectacular rise to glory and its dramatic fall from grace.

And I kept a diary.