Free To Trade

CHAPTER 2

The train lurched to a halt at the Monument station. Silently, about a quarter of the passengers stood up and picked their way through the carriage to the doors. I was one of them. We dropped on to the platform, and climbed the short flight of steps through the ticket barrier and out into the July sunshine. There our company of office workers split, and was met by a much larger battalion marching out of step across London Bridge. I joined a contingent striding up Gracechurch Street towards my offices in Bishopsgate. A few lost individuals struggled against the advancing army in an attempt to fight their way down the street. They were jostled and pushed for their temerity. Since 'Big Bang' the commuting crowd had started earlier and earlier, as salesmen, traders and settlements staff struggled to ensure that they were not the last to their desks to talk to Tokyo, or Australia, or Bahrain.

Although the army seemed unified by one purpose, getting to work and making money, each individual carried his own concerns, worries and responsibilities with him or her. Some days I would thrust myself through the crowd, eager to get to my desk and work on the problem that I had mulled over in my disturbed sleep the previous night. Other days I would drag my feet, jostled from behind, as I delayed the inevitable confrontation with yesterday's bad position. Often, I would just drift along with the others, my mind still asleep, shutting out the expected events of the day until I was sitting down with a cup of coffee in my hand.

Today, though, I rode above them all. I had made $400,000 in the last twenty-four hours; who knew how much I would make in the next? I had an irrational conviction that any trade I did would turn money into more money. I knew this would not last. But I should enjoy it while I could. Eventually luck would abandon me. Fifty-fifty trades would all go against me. Certainties would be blown away by the unforeseen. My computer would develop undetectable bugs. My job was like a drug with highs and lows. Was it addictive? Probably.

It was certainly more exciting than the large American bank I had joined after Cambridge. I had spent six years in the credit department, analysing companies that borrowed from the bank. I had to decide whether the companies would be in a position to give the money back. The job was intellectually interesting, but the bank had done its best to make it boring. It felt like a grey factory, staffed with grey workers who had weekly quotas of a certain number of pages of analysis to produce.

It had suited me though. The bank had been very understanding about the hours I kept. They obviously thought it was good public relations. The general manager of the London office was an American, an ex-college football player and a devoted sports fan. It was fine with him if I arrived at work late or left early. Holiday days were not counted scrupulously; I could have as much unpaid leave as I wished. The whole office was proud of its Olympic eight-hundred-metre bronze medallist.

They hadn't understood when I had given up running. None of them had. The general manager had taken it personally. There was nothing wrong with me. I was still young. In four years' time the gold medal was mine for the taking. How could I let him down like that?

The grey work got greyer. I was expected to work a full day. With nothing else to distract me, the drudgery became unbearable. I needed something new, a challenge, something to win.

So when I saw an advertisement in the Financial Times for a junior trader, I put together a CV and sent it in. The advert said that a small fund management firm, De Jong & Co., was looking for someone with good credit experience whom they could train to become a portfolio manager. After two more weeks of tedium, I had received a reply. They wanted to see me! I liked the people I had met at my interviews. I thought them both bright and friendly, people from whom I could learn a lot.

I was particularly impressed with the man I was to work for, Hamilton McKenzie. He was a neat, slim Scot of medium height, in his late thirties. His prematurely grey hair always looked as if it had just been cut, and he wore a beard which was carefully trimmed close to his chin. His blue eyes were cold and aloof until he focused them on you. Then they seemed to bore right into your mind, exposing everything, evaluating what was revealed. Indeed Hamilton appeared to be thinking all the time, judging, calculating. At first I found this intimidating, and could not feel comfortable in his presence. But he was an excellent teacher. He saw things clearly, and he explained things clearly. He often made me feel like an idiot for not reaching his conclusions, but he always took the time to lay out how he himself had arrived at them. His criticism, although harsh, was always constructive, and he was determined to teach me all he knew about portfolio management.

And he knew a lot. He had the reputation of being an inspired taker of risk. Much of modern portfolio theory emphasises the hopelessness of trying to beat markets which are efficient. Many modern portfolio managers concentrate on matching or narrowly outperforming the market. Hamilton thought this was ridiculous. His view was that the institutions who gave their money to De Jong to manage, paid their fees for ideas. He believed his duty to them was to make as much money for them as he could, any way he could. This meant he took risks, big risks. But he did not take them indiscriminately. Rather, he would wait until an attractive opportunity arose, analyse all the risks, avoid or hedge as many as he could, and then, when he was sure the odds were in his favour, make his move. De Jong & Co.'s clients were happy with the results, and gave him more money.

The firm had been founded by George De Jong twenty years earlier. It had originally managed the funds of a number of prominent charitable trusts. Since Hamilton had joined eight years previously, the firm had attracted clients from overseas, especially Japan, bringing the total funds under management up to two billion pounds. For the last five years Mr De Jong, who was now in his late sixties, had come into work only three mornings a week. He still retained total control of the firm, and made a very good living out of it. The funds were invested in bonds in a range of currencies, and the management of these was left entirely in Hamilton's hands. Six people worked for him, including me.

Jeff Richards was the most senior of us, with two decades of investment experience. His job was to determine which way exchange rates and interest rates would move, and position his portfolios accordingly. A mild-mannered man with a very academic approach to the markets, he was generally quite successful. Rob Greenhalgh helped him in this, and was also responsible for managing the non-dollar bond positions. He was about my own age and had been with the firm two years. We also had a 'chartist', Gordon Hurley. He used the technical analysis of historical prices to forecast future prices. This seemed to me little better than reading tea leaves, but Gordon got it right more often than he got it wrong.

My role was to look after the dollar portion of the portfolio, which represented more than half our funds. This was Hamilton's area of interest, and one in which he still played an active part. Eventually, the idea was that I should share this role with Debbie, who was even newer on the desk than I. At the moment she spent most of her time on administration and legal documentation, and on some of the more harmless trading. We all shared one assistant, a quiet but highly efficient girl of twenty named Karen.

I had been part of this team for six months, and I loved it.

I continued up Bishopsgate until I reached the tall, black-glassed headquarters of the Colonial Bank. As the Colonial Bank's fortunes had dwindled, so had its usage of its headquarters, to the point where it now let out the top half of the building. De Jong had the twentieth floor, two from the top. I took the lift up, and entered the plush reception area, all polished mahogany, worthy leather-bound books, and eighteenth-century prints of old trade routes and sleek tea clippers in full sail. The room gave the impression of solidity, of distinction, of wealth earned a century before by the financiers of imperial trade, of conservative investment decisions quietly taken. The reality was that the firm was only twenty years old, and its customers' money was daily wagered against the market by Hamilton and his team behind the oak doors.

I went through those oak doors and entered the trading room of De Jong & Co. This was much smaller than the trading rooms of the investment banks, or brokers that bought and sold securities from customers round the clock. As a relatively small investment institution, De Jong did not have many people. Although it was more active than other investment managers, the firm did not trade round the clock. We only bought or sold bonds when we had a particular view on the market.

Nevertheless, even in its quieter moments, the room exuded an atmosphere of suppressed tension, which I found exhilarating. Here the fate of two billion pounds was deliberated. Information flowed in from all over the world, either through the telephones, through the screens, or on paper. It was analysed, debated, picked apart and then put together. A decision was made; to buy one security, to sell another, or simply to do nothing. Each decision resulted in the movement of millions of pounds. If we got it right, our clients would be tens or hundreds of thousands of pounds to the good. If we got it wrong… The responsibility was taken seriously by all of us.

The room had two external walls that were entirely made up of thick glass windows. They faced south-east and south-west. From twenty floors up you could see right over the City of London to the low hills beyond Upminster in the east, the needle of the Crystal Palace mast in the south and the tower blocks of Middlesex to the west. The internal walls were bare except for the obligatory clocks telling the times in Tokyo, Frankfurt, London and New York, and a large white board covered in blue scribbles recording a trade we had executed months ago.

There were eight desks in the room. Each was equipped with the paraphernalia which is necessary to move money around the world; Reuters and Telerate screens, which provide up-to-the-minute information on prices, news and markets; personal computers for analysing portfolios and historical price data; a complicated phone system with a board displaying a dozen or so lines which flash rather than ring, and large wastepaper baskets for throwing away most of the two-foot-high pile of research received every day with the post.

One of the desks was larger than the others, slightly less cluttered, and was positioned a little away from the rest. Empty at the moment, it was the point from which Hamilton controlled the room, and devised his next strategy for beating the markets. Close enough to keep informed, far enough away to keep in control.

It was five past eight, and I was the last in this morning, as I thought I had every right to be. The room was fuller, and more active than it had been the day before. Rob was back from his holiday and Gordon from his seminar. They were both on the phone, and Rob's voice was raised to a level which suggested he was already exercised about something. Jeff was glued to his computer, in exactly the same position I had left him the night before.

'Morning,' I said, as I passed. I got a grunt in return.

I walked over to my desk, and turned on the array of switches above and below it. As the machines whirred into life, Debbie greeted me, 'Morning, smuggerlugs. Thanks for the drink last night.'

'Give me a break,' I said. 'Everyone gets lucky sometime.'

I opened my briefcase, and threw the previous evening's reading on to the desk.

'Don't tell me you actually enjoy that stuff,' said Debbie, pointing to a yellow pamphlet carrying the Bloomfield Weiss logo. She walked round to my desk and picked it up. ' "The Volatility of Volatility: How Information Decays over Time", by George Feuchtwanger Ph.D. That sounds a bundle of laughs.' She opened it up to a page covered with long equations each interspersed with tortuous sentences. 'OK, so what does that one mean?' she asked pointing to a particularly long string of Greek letters and Arabic numerals.

'It means "Good morning, Paul, please can I get you a cup of coffee",' I said.

'And this one means, "Go and get your own coffee, you lazy bastard,"' she said, pointing to almost as intricate an equation just below it. But she tossed the research piece on to the desk, and turned towards the coffee machine.

I liked Debbie. We had worked together for only two months, but in that time we had developed a good understanding. She thought I was too dedicated to my work; I thought she was not dedicated enough to hers. But she was fun. She put the minor ups and downs of the bond market into perspective. You never got a chance to take yourself too seriously with her around.

She was in her mid-twenties, small, with light brown hair, which she wore tied up in a pony-tail. She was probably a little overweight, although this gave her a softness which was attractive. A broad smile was never far from her lips, and her bright brown eyes never kept still, dancing from one object to the next.

She was a lawyer by training. After a couple of years of articles for a middling firm of solicitors, she had had enough of the law, and joined De Jong & Co. There she had not entirely escaped, since she spent her first couple of years in our 'back office' devoting much of her time to working on the legal structures of our funds, and on compliance with the stream of new regulations that were intended to make sure we didn't steal any of our clients' money. Eventually she had persuaded Hamilton to take her on as a junior trader. Despite giving the appearance of doing almost no work at all, she had been quick to learn.

She got on well with everyone in the firm. Even Jeff Richards warmed to her banter. Only Hamilton seemed to have equivocal feelings towards her. For him, there could be no excuse for a lack of commitment.

I looked at the research piece lying open on my desk. Debbie had happened to pick the exact point in the article where I had finally lost track of Dr Feuchtwanger's argument. I had wrestled with it for an hour and a half the previous night before giving up. Although the article had no direct relevance to what we were doing, I was eager to learn as much about the bond markets as I could. There is a limit to how much you can pick up about bond-trading from reading, but I wanted to reach that limit. However complicated or arcane the article, I would plough through it in my attempt to catch up with the combined knowledge of all those traders and fund managers out there.

Debbie soon returned, bearing two plastic cups of gritty black liquid. She handed me one and sat at her desk, the television-review section of the Financial Times spread out in front of her. During the day, she would get through the FT, The Times and the Mail.

One of our lines flashed. It was Cash.

'Boy, you guys at De Jong are getting real lucky,' he started. 'Yesterday I bring you the sweetest of trades. Today I get you out of a hole.'

'And what hole is that?' I asked, slightly worried. I didn't realise we were in a hole. I ran through our various holdings in my mind, trying to think of what Cash could mean.

'I've got a bid for your Gypsums,' Cash said, a note of triumph in his voice. 'I will bid 80 for all your bonds.'

'Hold on,' I said. At first I wasn't sure what he meant. Then, riffling through the papers on my desk, I dug out one of our client portfolios. There amongst a group of odd lot holdings was 'Gypsum Company of America 9% 1995'. The purchase date was three years before, and the purchase price was 96.

Covering the mouthpiece with my hand, I leaned back, and shouted, 'Hey, Jeff!'

Jeff looked up from his computer, slightly annoyed at being disturbed in his analysis. 'Yes?' he replied.

'Do you know anything about half a million dollars of Gypsum of Americas? It looks like we bought them three years ago.'

Jeff frowned for a moment. 'Yes, I think I know what you mean. Not one of Hamilton's best positions. I think he bought them close to par. Then the company got into trouble, and they were last seen trading in the sixties.'

'I've got a bid here at 80,' I said.

'Then take it.'

I thought for a moment. If Cash was suddenly bidding 80 for a bond which had been trading at a price of 60, there must be something he knew that I didn't.

'Is there anything I should know about Gypsum?' I asked Cash.

'No, nothing I'm aware of. Hey, Hamilton was belly-aching at me all last year to come up with a good bid on this position. Well, I've finally got one. He'll be pleased when he hears.'

This was the old tactic that salesmen used on junior portfolio managers when their bosses were away. Tell the junior what the boss would do in a similar situation, and make him think there is more risk in not doing a particular trade than in doing it. I had fallen for this once or twice in my first couple of months. Hamilton had given me a lecture about how I should always trust my own judgement, and never believe what others might say his views were.

'Hmm,' I said. 'I am going to need some time to think about this. I'll call you back.'

'Well, get back to me by this evening. The bid may not be there tomorrow,' Cash said.

'OK. I'll talk to you this afternoon,' I said, and hung up.

I needed to find out more about the Gypsum Company of America. I left my desk, and went through a door at the back of the trading room to the library.

'Library' was probably too grand a name for the small, windowless room. There were hardly any books. The walls were stacked high with files, and there was a computer in the middle of the room, which was linked to a host of different information databases. Alison, the part-time librarian, was out, but I knew my way round most of the sources of information. Within twenty minutes I had extracted the prospectus for the Gypsum bond we held and reports from stockbrokers on the company. I also printed off the accounts for the last five years and press reports over the last year from the computer.

I carried the armfuls of paper back to my desk.

Debbie looked up from her Times. 'It's not that cold in here. No need to start a bonfire.'

'I just want to see if there is anything going on with this company,' I said.

'Typical Paul,' Debbie said. 'Anyone else would just have read the latest Valueline, and then sold the bonds.'

I smiled. Debbie was probably right. But then, as she well knew, I wouldn't be satisfied until I had analysed the accounts going back five years, and read all the press and analytical comment on the company I could find.

I spent the next three hours going over the material, stopping only for quarter of an hour to get a sandwich from the small shop over the road.

As I read, I began to build up a picture of a company which had started off mediocre and over the last two years had become a basket case. It wasn't all the company's fault. Its main product, wallboard, had been in less demand as housing construction had declined sharply. However, the company had not been helped by the actions of its chairman and 30 per cent owner, Nat Morrison. He had borrowed heavily to build factories which were now operating at half capacity. He had also fired a succession of chief operating officers over 'policy' differences. As the company's earnings had turned to losses, the prices of Gypsum's shares and bonds had fallen sharply. The market thought there was a strong likelihood the company would not survive.

The company had received a number of overtures from large conglomerates, looking to buy its modern factories cheaply in preparation for the upturn in the economy which must eventually occur. But Nat Morrison would not give up his chairmanship. And no buyer in his right mind would want the company with Nat Morrison in charge. But, since his support was crucial for any takeover to succeed, none could occur, and the company's position continued to deteriorate.

Then, going through the press reports, I came across a headline dated about a month ago: 'Wallboard King dies in Helicopter Crash'. 'Wallboard King' was perhaps a flattering term for Nat Morrison, but it did mean him. He had died in his helicopter whilst visiting one of his factories. I read the reports of the next few days closely. Not surprisingly, the share price had risen 10 per cent on the news. He had apparently left his money in a trust. His son, a successful Chicago lawyer with absolutely no interest in wallboard, was the trustee together with a local bank president.

I stood up from my cluttered desk, and wandered over to the window. I stared at the silver line of the Thames cutting its way through the tall black and grey buildings of the City, past the more sedate St Paul's Cathedral and Houses of Parliament and on towards the squat lump of Battersea Power Station. Why was Cash bidding so high for the bonds? Who was the ultimate buyer? And why?

With the old man Morrison gone, a takeover would be a possibility, especially since a lawyer and a banker would be more likely to see the financial sense in the sale of the family firm. I supposed that if Gypsum were taken over by a sounder company, then the bonds would move up in price. But a takeover was far from certain, and the company could easily go bankrupt in the meantime. If a speculator wanted to gamble on a takeover, it would make more sense for him to buy the stock, which could easily double. In comparison, however strong the acquiring company was, the bonds would always be redeemed at 100, which was just a 25 per cent profit on the price of 80 which Cash was bidding.

So who would want Gypsum bonds? Perhaps the company was buying back its own bonds cheaply? No, Gypsum didn't have the cash.

I watched a barge push its way under Blackfriars Bridge.

Of course! There was only one logical buyer! Someone was about to take over Gypsum. But before they made their intentions known to the market, they would gather as many Gypsum bonds at a discount as they could. There were $100 million Gypsum bonds outstanding. If they could buy them at an average price of 80, then that 25 per cent profit when the bonds were redeemed would be worth $20 million, a significant sum. The more I thought about it, the more I was sure that this was the most logical explanation. To work!

I strode back to my desk. I called David Barratt. 'Harrison Brothers,' I heard him say.

'David, have you heard of an issue for the Gypsum Company of America?' I began.

David had an excellent memory, and knew the details of most of the bonds still in existence.

'I certainly have,' he said. 'The 9 per cents of 1995. Last I saw, they were trading at 65, but that was six months ago.'

'I wonder if you could get hold of five million dollars for me?' I asked.

'It's going to be difficult,' David said. 'The issue hardly ever trades. I'll see what I can do.'

I put the phone down. Debbie, as usual, had heard it all. 'I thought you were supposed to be selling these bonds not buying them. Hamilton will have a fit when he finds out.'

I explained what I had discovered about Gypsum, and the conclusions I had drawn. 'If I'm right, and the bonds are being bought by someone who is about to take over the company, then they are going to trade right up to par. If I can buy any at 80, that's 20 points profit.'

Debbie listened carefully. 'Sounds like a great idea to me. I still think Hamilton will have a fit.'

I winced. She might be right. Technically I was not authorised to increase De Jong's exposure to any company that did not have the top credit ratings of AAA or AA, without Hamilton's permission. But I knew what I was doing made sense.

The phone flashed. It was Cash. 'Have you made up your mind on the Gypsums yet?'

'Not yet. Give me another half an hour.'

'OK. But my bid isn't going to be around for ever. Half an hour is all you have got.' Cash rang off. He was just a little tenser than usual. There had been none of the usual banter.

It was twenty-five minutes before David came back. 'There's something going on. There is an 80 bid in the street for these things, God knows why. Do you know what's happening, Paul?'

'I don't know, but I can guess,' I said.

'Well?'

'Sorry, David, I can't say. Did you find any bonds?'

'Only two million. We can offer them at 82.'

Harrison Brothers was probably taking at least a point out of the price, but now wasn't the time to quibble. 'I'll take them,' I said.

'You buy two million Gypsum of America nines of ninety-five at 82,' David said. 'Thanks for the trade.'

'Thank you,' I said. 'If you come across any more, let me know.'

'I will,' said David. 'But I think it unlikely. We had to scour Switzerland for these two. Someone has cleared up all the available bonds. Everyone we spoke to had sold in the last day or two.'

Still, at least I had amassed $2 million. That should make a tidy profit. I remembered my promise to call Cash back.

'Well?' he asked.

'I'm sorry, Cash. Thanks for the bid, but I think I would rather keep them.'

'Hey, Paul buddy. Think this through. Hamilton's going to be awful sore with you when he hears you didn't hit my bid.'

And when he finds out I bought two million more, I thought.

'Sorry, Cash, but we can't help you.'

There was silence for a moment. Then Cash's voice came back on the phone, disappointed, but friendly. 'That's your decision. Just remember the trouble I went to to help you out of a bad position. Speak to you later.'

As I put the phone down, I marvelled at Cash's ability to make you feel guilty, even when he was trying to rip you off.

'Did you get any?' Debbie asked.

'Only two million,' I said.

'That's not bad. You should make some decent money out of that.' She sat back in her chair. 'It's a shame we can't buy any of the bonds ourselves,' she said. 'It looks like easy money.'

'Of course you can,' I said. 'All you need to do is take a couple of million out of your building society account.'

'We could try and buy a smaller amount. An odd lot,' she said.

'Would that be ethical?'

'I don't know.'

'Well, you ought to know, you are the compliance officer after all,' I said. Every fund management company appointed a compliance officer to ensure that insider trading and conflicts of interest were avoided. With her legal background, Debbie had become ours.

'I suppose I am.' She paused. 'Thinking about it, it would almost certainly be a conflict of interest.'

'Shame. It's not a bad idea,' I said.

'Of course we could buy the stock,' Debbie said. 'That should move up sharpish if the company is taken over.'

'Why not?' I said, 'Seems like a great idea to me.' I had ten thousand pounds in the building society. It seemed to me that Gypsum shares would be a good place to put half of it. 'But how the hell do you buy American shares?'

Debbie and I mulled over this problem for a minute or two. Then Debbie laughed, 'This is ridiculous! We've got ten lines all plugged in to the biggest stockbrokers in the world. One of them should know!'

'Of course!' I said. 'I'll ring Cash. He's bound to know all about that sort of thing.'

I got through to Cash. 'Changed your mind about the Gypsums?' he asked.

'No, I haven't,' I said. 'But I wonder if you could do me a favour?'

'Sure,' said Cash, perhaps a little less enthusiastically than usual.

'How can I buy some stock on the New York Stock Exchange?'

'Oh, that's easy. I can get an account opened for you here. All you have to do is call Miriam Wall in our private client department. Just give me five minutes and I'll warn her you are coming through.'

Ten minutes later Debbie and I were proud owners of a thousand shares each of Gypsum of America stock bought at a price of $7 per share.