There is always someone in the investing world enjoying stellar recent performance. Wall Street attracts the sharpest minds, equips them with cutting-edge technology, arms them with an endless pool of investor capital, and incentivizes them with unfathomable riches. Thousands of fund managers allocating capital with limitless ideas. Someone is always crushing it year to date. Someone was printing money during the crypto melt up in 2021. Someone else got rich shorting long-dated bonds in 2022. Someone began furiously buying call options on Nvidia in 2023 and held on for dear life. Someone else turned their portfolio into a bet on AI memory stocks last year.
The manager with the best year-to-date performance gets all the headlines. Profiles in the Wall Street Journal, appearances on the most downloaded podcasts. But here is the thing about astronomical short-run returns.
They can only be achieved by taking astronomical levels of risk.
And the thing about astronomical risk is you often don’t realize it’s there until the damage is done.
Anyway, here’s a story that made the rounds recently. In June 2024 a 22-year-old former OpenAI employee named Leopold Aschenbrenner wrote a 165-page manifesto proclaiming the impending arrival of artificial general intelligence – superintelligence exceeding human capabilities. The paper was titled Situational Awareness, inspired by the following paragraph in the introduction:
Before long, the world will wake up. But right now, there are perhaps a few hundred people, most of them in San Francisco and the AI labs, that have situational awareness. Through whatever peculiar forces of fate, I have found myself amongst them. A few years ago, these people were derided as crazy - but they trusted the trendlines, which allowed them to correctly predict the AI advances of the past few years. Whether these people are also right about the next few years remains to be seen. But these are very smart people - the smartest people I have ever met - and they are the ones building this technology. Perhaps they will be an odd footnote in history, or perhaps they will go down in history like Szilard and Oppenheimer and Teller. If they are seeing the future even close to correctly, we are in for a wild ride. Let me tell you what we see.
This paper became required reading in Silicon Valley and earned Aschenbrenner the sobriquet “the Nostradamus of AI.” Capitalizing on the notoriety, he naturally started a hedge fund and named it Situational Awareness. Investors scrambled to wire the Nostradamus of AI their money. As everyone who eschewed a diversified portfolio for a bet on the AI-theme in 2024 and 2025, they were rewarded. Situational Awareness shot the lights out the last two years. Aschenbrenner’s portfolio largely consisted of a private stake in Anthropic (it helps when you marry the CEO’s Chief of Staff), concentrated long positions on AI infrastructure names (memory, energy, neoclouds, etc.) and short positions (a bet against – enabling an investor to profit if the stock loses value) on software stocks. Given his belief he was one of a few hundred people possessing situational awareness, he levered his portfolio up four times.
Four times.
Meaning for every dollar of investor capital, he borrowed and invested another $3. Leverage mathematically amplifies both gains and losses. Leverage on concentrated positions enabled his fund to achieve astronomical returns from its inception 2024 through the first half of 2026.
But 4x leverage means a 25% decline in your positions wipes out your entire equity position. Zero. Gone. Forever.
By the beginning of July, Situational Awareness ballooned to $45 billion. Midway through the month, the market began moving against him. His long positions suffered a sharp decline and the short positions popped (shorts lose money when the securities sold short increase in value). The addition of leverage to a concentrated portfolio spelled destruction. In July, Situational Awareness suffered a 67% drawdown compared to a 5% drawdown in the Nasdaq-100 while the S&P 500 was flat. He was forced to sell his entire public stock portfolio to Citadel at a discount to avoid being liquidated.
This episode reminds me of a quip from Steve Cohen, the hedge fund manager Bobby Axelrod’s character in Billions is inspired by, a few years ago:
“Oh, listen, you’re gonna lose money, okay? You’re gonna take risk, you’re gonna lose money. I think the three things are: liquidity, leverage, and concentration. Those are the three rules. If you’re in illiquid stuff, that’s a problem. If you’re using too much leverage, that’s a problem. And if you are too concentrated, that’s a problem. So doesn’t mean that if you have one of them, maybe it works, if you have two of them, uh oh. If you got three of them, you’re whistling past the graveyard.”
Leopold broke two of those rules – concentration and leverage. I will add a fourth rule: hubris. Lifetime returns are inversely correlated with an investment manager’s degree of hubris. Hubris comes from a Greek word describing mortals seeking to break natural rules or act equal to the gods. We see a lot of hubris among portfolio managers in our business. It is as understandable as it is ubiquitous. A taste of success breeds confidence which often metastasizes into hubris. Sometimes we wonder if clients get tired of hearing us respond we don’t know when they ask us questions about the future. What will happen to the market now that the Strait of Hormuz is closed? What if the Fed hikes rates in September? What will happen to SpaceX when it IPOs?
Every time we answer questions about the future with the admission that we don’t know we’re intentionally pushing back on that natural hubristic voice within us whispering that we are endowed with a unique measure of clairvoyance. That we too will have the historical import of Robert Oppenheimer or Leo Szilard. We must remind ourselves as often as we remind those who have entrusted us with their financial plans.
I don’t know the future. You don’t know the future. No one in the markets knows the future. Fortunately, prescience is not a necessary condition for long-term investing success.
But believing you can see the future is a sufficient condition for long-term investing failure.
There are four rules.
Sean Cawley, CFP®
Sources:
https://situational-awareness.ai/
https://www.wsj.com/finance/leopold-aschenbrenner-situational-awareness-ai-fund-597633d3
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This commentary reflects the personal opinions, viewpoints, and analyses of Resolute Wealth Management. It does not necessarily represent those of RFG Advisory, clients, or employees. This commentary should be regarded as a description of advisory services provided by Resolute Wealth Management or RFG Advisory, or performance returns of any client. The views reflected in the commentary are subject to change at any time without notice.