Blackjack, how to play the bond market

Scott Patterson from the WSJ interviews Edward Thorp (Hedge fund manager and author of Beat the Dealer and Bill Gross (managing director of Pimco) about risk management and the state of the markets. Here are some interesting excerpts:

WSJ: What's your assessment of the state of hedge funds today?

Mr. Thorp: In the last 15 years or so, there has been a large flow of capital into the hedge-fund world, from $100 billion in the early 1990s to $2 trillion now. But the amount of available investing opportunities hasn't increased that much. That has led to the over-betting phenomenon Bill and I were talking about, or gambler's ruin.

Hedge funds started using a great deal of leverage to increase returns. But you can get wiped out if you bet too aggressively. A classic example is Long-Term Capital Management [the huge hedge fund that blew up in 1998]. We'll probably be seeing more of that now.

WSJ: Is there more leverage in the system now than ever before?

Mr. Gross: Goodness yes. The critical jolt came through housing, through the real economy, when homeowners became so overly levered relative to the equity in their home -- in many cases there was no equity, which is like super-leverage. Ultimately, some level of interest rates, or some level of caution by lenders to extend further credit, meant we were going down. Now we are finding out the consequences.

Read the entire article here.

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