Chapter 17: Stress

October 11, 1983, Kenosha, Wisconsin

On Tuesday, I went to the office to write my daily report, and at 9:00am, I left for my appointment in Kenosha, where I’d present to the police and firefighters’ unions, then have lunch with the union leaders. I met Chris Roth, the pension manager who handled both unions’ accounts in his office.

“You’ll be meeting with the union leadership of both unions,” he said. “In addition, the Police Chief and Fire Chief will be in attendance. They don’t have a vote, but their influence could easily affect the unions’ decision. Someone is sure to raise your age as a concern.”

I nodded, “I’ve answered those questions several times, and my response is that I hold two securities licenses and have about a hundred million in assets under management, with a projected annual return of just over 30%. Obviously, I can’t guarantee that, but I will happily provide a list of trades in addition to the prospectus.”

“How did you achieve that return in your first year?”

“My main job is as an analyst, and together with some other analysts, we developed proprietary computer programs to help analyze currencies and national economies. I obviously can’t disclose the formulas we use, but I can say we are innovative, and our innovation in data analysis helps us stay a step ahead of other firms.”

“Won’t they figure it out, too?”

“Yes, they will; our advantage is having the strongest research team in the industry, and having Noel Spurgeon leading the firm gives us advantages a larger company does not have, including agility and speed to act.”

“My counterpart in Overland Park sang your praises. The chiefs will certainly speak to their counterparts as well.”

“I’m not at all concerned about that,” I said. “I think the numbers speak for themselves, especially when combined with Spurgeon Capital’s track record and reputation. There is nobody better on Wall Street. Of course, as our prospectus says, and we are required to remind you, past performance is not a guarantee of future performance. That said, I believe my investment strategy will continue to be successful, including in a down market.”

“I’m curious about that. How do you make money in a down market? Usually, we look to move to bonds or Treasuries.”

“Which made perfect sense once Volcker ratcheted up interest rates. My strategy in a down market is to find counter-cyclical investments, be they currencies, precious metals, or securities, and use a range of trading tools to produce market-beating returns, both in an up or down market. In addition, with the hurdle set at 8%, I have a strong incentive to beat that! And I believe I will. I can’t tell you upfront exactly what I will do because it’s highly dependent on market conditions.”

“What are the minimums for individuals?”

“A hundred grand,” I replied. “And that needs to be investable assets because there is a one-year lockup period.”

“Few people have the means to invest as much,” he acknowledged.

“For anyone with less, a no-load S&P fund would be their best bet. It’ll return the market rate minus fees and expenses. It has similar risks to investing with me, but because it maintains a ratio of investments that matches the S&P 500, you get the dogs with the outstanding performers. You pay me two and twenty to avoid the dogs.”

“You’ll need to explain that to the union leaders and be prepared for some pushback.”

I nodded, “I understand.”

I took the opportunity to use the restroom, then got a glass of ice water. We walked to the conference room where I’d make my presentation. Chris introduced the ten people in the room, and I repeated their names silently to help me recall them. Once the introductions were complete, I began my presentation, which lasted fourteen minutes, just over the guideline that after twelve, you began to lose the attention of the audience.

“Any questions?”

“Let me get this straight,” Bill Fowler, a firefighters’ union rep, said, “You skim 2% of the money we give you, then take 20% of the profits?”

“20% of the profits over the hurdle rate of 8%. In the packets I’ve handed out, there is a printout of a spreadsheet that provides a concrete example. If you would take that out, I’ll go over it.”

They did as I’d asked.

“As you can see, it assumes you have $100,000 to invest, which means you would be charged $2000 the first year by Spurgeon to manage the fund, no matter how well or how poorly the fund performs. That money is deducted from your investment, beginning with the initial investment and then each year following.

“Looking at the details, with a hurdle of 8%, Spurgeon Capital retains 20% of the annual gains in excess of 8% after the fund is ‘marked to market’, that is, the value is calculated at the closing price on a fixed date. If we can’t ‘beat the street’, as it’s called, we make no profit, as the 2% management fee covers expenses, including salaries, leases, and equipment, as well as trading fees.

“Putting real numbers behind it, if we use Spurgeon’s annualized return last year across all funds of 32%, if you invested $100,000, the value of your investment at the end of the year would be about $131,500, after allowing for the initial 2% management fee. Of the $31,500 gain, the first $7800 or so is yours, free and clear. Of the remaining $23,500 gain, about $4700 would be retained by Spurgeon, yielding around $19,000 in gains, for a net total gain of $26,000, or about 26% on your initial investment. That’s about triple the return you’d earn in a Dow or S&P fund, assuming typical annualized returns.

“And that difference adds up. The ‘Rule of 72’ says that you divide 72 by the rate of return. Using the hurdle rate, which is 8%, the result shows that your money doubles roughly every nine years. Let’s make it ten to allow for the fees, and that means your money doubles five times — $200,000 in ten years, $400,000 in twenty years, $800,000 in thirty years, and $1.6 million in forty years. And that’s if I only make the hurdle rate or slightly above.

“Now, consider a return of 20%. The way to calculate the length of time it takes to double is a bit different but works out to about four years. In other words, you would double your money two and a half times over each ten-year period. In thirty-two years, that hundred grand would be worth something on the order of $12 million after accounting for our fees. Those calculations are in Table 2 on the same page.”

“And you can do this every single year?” Al Crowe asked.

“That’s the goal, yes. I can’t guarantee it, but I have a vested interest in beating the hurdle rate, which is slightly more than the long-term Dow Industrial annual gain. I only make money if I do that. In addition, my money is right next to yours. All of my investable funds are in either the Cincinnatus Fund or the Spurgeon Select Fund.

“Those funds have different trading parameters, with the Cincinnatus Fund being more conservative. I use a set of strategies that trades a small portion of potential gains for protection from losses. It’s not perfect, of course, but it ensures that I can unwind a bad position with as little harm as possible. Given this is pension money, you want that slightly lower return in exchange for significantly lower risk. Not no risk, mind you, but lower.”

“Yes or no,” Jack Colton said. “We could lose all of our money.”

“Yes. Just as you could in your current investment portfolio. Granted, it’s mostly in Treasuries and bonds, but with interest rates trending down, those bonds are going to be called and replaced with ones which pay less, and no matter how highly rated they are, there is always a risk of default.

“As for Treasuries, those are as safe an investment as you can find, but they have no real upside in terms of capital gains, and every new treasury you buy yields less than the previous one. In general, in the long run, you’ll barely keep up with inflation with that strategy; I do use government securities to generate income to prevent forced liquidation for redemptions or pension fund payouts. And they provide a firm base for the remainder of my trading without interfering with my total gains in a significant way.”

“I have to ask,” Chief Brock said. “How old are you?”

“Twenty,” I replied. “I’ve been working for Spurgeon for two years, and as Mr. Roth said when he introduced me, I hold two securities licenses and am working towards a third. The two licenses I have allow me to broker anything other than real estate and insurance, though I can purchase those products for my fund. The license I’m working on will allow me to manage other licensed individuals. What Mr. Roth didn’t mention is that I’m the youngest double-licensed professional at Spurgeon, and I oversee all firm research.”

“Were you one of those prodigies who went to college at sixteen?”

“No. I have a High School Diploma, and I’m taking night classes at the University of Illinois Chicago Circle campus. Degrees aren’t required for my job; being an expert analyst is. And I am an expert analyst, as my track record clearly demonstrates.”

“That’s some serious chutzpah!” Josh Green, a police captain, said.

“Not to be impertinent, but the numbers back that up. And the value of my youth is that I have new ideas and new ways of looking at things. One of our major innovations is using personal computers to aid us in our analysis and modeling, and we’re the first firm of our size to actively employ full-time data analysts. I helped develop the first spreadsheets and models, then turned that work over to a computer expert because I have to focus on the markets.

“In your packet is a daily analyst report I wrote about four months ago. My team produces a comprehensive report across all sectors and investment vehicles, along with a ‘state of the world’ analysis, which you see in the sample report I provided. A small portion of the report has been redacted to protect Spurgeon’s trade secrets, but you can see the quality of my analysis.”

There were a few more questions, mainly about the details of the spreadsheets I had provided, and I reviewed the math in more detail, ending about forty-five minutes after I’d begun. We had lunch together, then I headed back to Chicago, reasonably confident I had another $5 million in the bag.

October 11, 1983, Chicago, Illinois

“How did it go?” Murray Matheson asked when I stopped in his office just after returning to the Hancock Center.

“I’m reasonably confident I have them,” I said. “The pension fund manager said he expected a decision from the two boards by the end of the month.”

“Good. How are things working with the researchers?”

“So far, so good. We’ll gel once we’re all in the same area. Right now, with everyone spread around, collaboration is limited. But the reports are being distributed, and the quality has improved from before the change.”

“That’s good. Shut the door.”

I did as he instructed.

“Nothing will come of this, but Enderlee flagged you to the SEC for insider trading and front running.”

“Seriously?!” I asked, suddenly nervous, which I was sure showed.

“Seriously,” Mr. Matheson said. “Don’t sweat it. You document things better than anyone here, and your analysis will hold up. Compliance sent them your trades and your analyst reports. You are squeaky clean. Hell, they might not even bother to interview you.”

“So what happens to him?”

“They’ll treat it as a whistleblower who had bad information. It won’t hurt him with the SEC or the CFTC. That said, you can imagine Noel Spurgeon’s reaction.”

“Enderlee is now toxic and will be lucky to find a job flipping burgers.”

“And his funds will remain locked up for the entire redemption period.”

That meant he couldn’t have them for a year. And that was all part of the employee handbook and had been expressly noted in my employment contract, which I had signed and agreed to. And I was sure that was the case for everyone else.

“Ouch,” I replied. “That’s going to hurt.”

“It will. One does not cross Noel Spurgeon without paying the price.”

“No kidding.”

And that right there was a reason that, despite some people pushing me to think about starting my own firm, Noel Spurgeon could block it and ruin me. It also meant I needed to have sufficient resources outside Spurgeon so that if something terrible happened, I wasn’t completely screwed. The income-producing properties would help, as would the savings account I was building. In my mind, I needed to have enough liquidity to survive the entire one-year lockup period.

And that was why Enderlee was so severely screwed. He, like many of the traders, was cash-poor, and he lived above his current means based on his trading record over the past year. He could, in theory, lose everything if he didn’t have sufficient assets outside of Spurgeon, which I suspected he did not.

“Just keep doing your job, Kane. This will blow over, and Noel took it personally because it impugns the whole firm. You were just a target of opportunity for a disgruntled ex-employee. Dismissed.”

I left his office and returned to my desk to review the day’s reports, once again making notes about format improvements and content I thought could be improved or added. Just after 3:00pm, I left the office and headed home to spend time with Keiko before class.

“Doctor Morrison called,” she said after her grandmother left. “My blast count is 8%, which fits with the circumstances. What will matter is the next test, which will be done on the 31st.”

“What about the rest of the numbers?”

“My white count is elevated, as expected. He prescribed an oral antibiotic to see if it has any effect and also to help with any secondary infection that I might have. Jennifer will pick it up on her way here tomorrow.”

“What did you say to your grandmother?”

“Just that the tests showed no real change. I wanted to talk to you before I said anything.”

“You tell me what you want to do,” I said.

“I think we wait until the next tests or something else changes.”

“That’s fine.”

“I received a call from Loyola, and they’ll allow me to enroll in the correspondence courses they have that are used for prisoners or the military. What do you think?”

“My first response is that it’s up to you, but I know you want my opinion, so I’ll say you should do it. It gives you something productive to do, and if things don’t go the way we’re expecting, you’ll have those credits.”

Keiko smiled, “Always the optimist.”

“I don’t know if that’s the case, but I’m not a defeatist.”

“You do always look for the positive outcome in every situation.”

“And do my best to protect against the negative outcomes. Unfortunately, sometimes there is no way to do that.”

“You know it’s not your fault, right?”

“Neither is it yours,” I said. ‘It’s one of those unexpected events that just happen, and all we can do is manage them as well as possible.’

“How did your meeting go today?”

“I’m reasonably confident they’ll come on board. It’s a smaller deal than the trust funds that are coming on board, but every bit counts. Oh, and today there was an object lesson about what happens if you cross Noel Spurgeon.”

“Oh?”

“The trader I told you about, Enderlee? In addition to being fired, Mr. Spurgeon is going to hold all of his investments for the entire one-year lockup period. Enderlee is basically screwed, as he’s one of those people who was living right up to his income, and by that I mean previous years. He was having a bad year, so his income was far less, and now he can’t touch his money for a year. Add in the fact that he’ll never get a job in the industry, and he’s likely to lose his house if he doesn’t have enough money outside Spurgeon, which I suspect he might not.”

“Whoa!”

“Yeah, and that confirms my plans to buy income-generating properties and to plow as much cash into savings as possible so we have at least a year of expenses available. That would take us past any lockup period.”

“So there’s no way you could go, then?”

“If my investors came with me, it would just be my money that was locked up. But obviously, all of this means leaving isn’t something to contemplate doing casually, and not even in a considered way unless things were untenable and I was positive I could make it work and had written commitments from my investors. Even then, I feel I’d have to negotiate, and Noel Spurgeon would be in a position of strength and would know he had the ability to crush me.”

“It almost sounds like you’re being held hostage.”

I chuckled, “Because I am being held hostage! But it’s a pretty nice captivity, wouldn’t you say? And remember, I can leave anytime, and within a year, have all my money, minus what hasn’t vested. I can find something else to do at that point because so long as I don’t screw over Mr. Spurgeon or try to go to another firm, he won’t blackball me. There are no bars on the prison, and I can walk away.”

“Would you?”

“If I had a good enough reason, yes. And before you ask, I have no idea what that might be! I do need to eat so I can leave for class when Bianca arrives home.”

We went to the kitchen, and I ate leftovers, and when Bianca came into the house, I kissed Keiko and headed to class.

October 14, 1983, Chicago, Illinois

The closing on my properties was set for 10:00am on Friday, and I arrived ten minutes early at Chicago Title. Nelson met me there and verified I had the necessary documents from Goldman, as well as a cashier’s check in the proper amount. I confirmed I did and refrained from pointing out he’d asked me those questions when I’d called him on Thursday morning after Chicago Title had provided the amount for the check.