Hanergy Thin Film: Losing A Fortune – Not Just For The Billionaires by Covenant Capital Management
By now you may have seen the story of the remarkable loss experienced by Chinese billionaire Li Hejun earlier this week. As reported by CNBC:
Li, who was China’s richest man until this week, saw his fortune drop by as much as $15 billion in a half-hour as the stock in his company, Hanergy Thin Film Power Group, fell by nearly half. Trading in the shares was halted Wednesday and Li didn’t attend the company’s annual meeting.
While we aren’t particularly interested in the personal finances of Mr. Li, there are ripples from this story that have implications for the broad investment community.
Devastating surprises can occur in any investment at any time. The probability of a one-day 50% loss in any publicly traded company is essentially non-existent according to the statistical trappings of the efficient market hypothesis. Any financial model based on the normal distribution of markets (many of them) would have been critically exposed by the drop of Hanergy Thin Film Power Group.
This anomaly is not restricted to Mr. Li’s company. The CNBC article touches on two other publicly listed companies, Goldin Financial and Goldin Property, which also each incurred losses in excess of 40% this week.
“ In July 2002, the [Dow Jones] index recorded three steep falls within several trading days. (Probablility: one in four trillion). And on October 19, 1987, the worst day of trading in at least a century, the index fell 29.2%. The probability of that happening, based on the standard reckoning of financial theorists, was less than one in 1050- odds so small they have no meaning. It is a number outside the scale of nature…Everyone knows [that] financial markets are risky. But in the careful study of that concept, risk, lies the knowledge of our world and hope of a quantitative control over it.” –Benoit Mandelbrot
Risk is always involved in any investment, usually more than you think. We tend to say that risk is the difference between expected worst loss and realized worst loss. While the article notes that analysts had suspicions of stock manipulation and a runaway valuation, we suspect that very few of them called for a 50% drop in the company’s market value. To that end, reports of analysts retiring on the heels of enormous profits made shorting the Hanergy Thin Film Power Group are conspicuously absent. For the financial community at large, predicting any movement of that magnitude is not only statistically impossible, it’s occupationally hazardous.