#125 - John Arnold: The most prolific philanthropist you may not have heard of

KEYPOINTS

• 01

  John Arnold started trading as a teenager

  At 12 he knocked on doors for lawn work. By around 14, during the 1988–90 boom, he was renting $30 tables at trade shows to sell baseball cards and learning arbitrage, buying cards in one market to sell in another. His father's Crohn's disease meant he got a driver's licence at 14 to help the family. He joined Enron in 1995, driving from Nashville to Houston the weekend after graduating.

• 02

  Enron's gas desk was built on deregulation and merit

  Natural gas deregulation was completed in 1992, and Enron became a gas merchant and market-maker. In the winter of 1996, the first big price blowout after deregulation, Arnold was supposed to be on a six-month rotation but stayed on the trading desk. He was head trader on the largest gas-trading desk in the world at about 25. He describes the culture as very merit-focused and his own approach as total focus: you couldn't tell a best day from a worst day by watching him.

• 03

  He didn't see the fraud coming

  Arnold says he doesn't have a full answer to how the trading desk could make so much money while the company went bankrupt in November 2001. The problems sat in the CFO's office, on the financing side. He was fixated on 'The Smartest Guys in the Room' when he read it years later.

• 04

  His hedge fund took over the middleman role

  After Enron collapsed, many dealers left energy trading in the first half of 2002, and the market became very inefficient and willing to pay for intermediation. He launched his fund in mid-2002, initially letting investors put in only 25% of what they wanted. Early trades were mispriced on risk and reward, such as a bet on a cold winter in 2002, and returns were dramatic: he recalls up 36% in a month, and 150% in three months. He stresses that value at risk, not just value, is what matters.

• 05

  Amaranth versus the market, not versus Arnold

  Brian Hunter made a fortune in 2005, the Hurricane Katrina year, with a long, bullish position. By 2006 supply was ample and the market bearish, but Hunter kept buying, propping up prices and distorting relative values. Arnold says the popular 'me versus him' story is wrong: it was the whole market versus one huge position, which collapsed as hurricane season began without storms.

• 06

  Fundamentals and probability drive his thinking

  Arnold asks what the world looks like if weather is at the 90th, 99th or 10th percentile, and how the price compares with fair value. He brings the same discipline to philanthropy, asking what the evidence really shows.

• 07

  Why he quit trading at 38

  He met his wife in early 2006, and his time on philanthropy grew from about 3% to 10–15%. Competitive markets demand 100% focus, and at 90% it got harder. Natural gas prices peaked around mid-2008 and volatility then declined. By 2012 he had shut down his fund, after about 24 months building the confidence to leave.

• 08

  Philanthropy is tiny compared with government

  Arnold breaks the US economy down as roughly 60% private sector, 40% government and about 2% philanthropy. Excluding giving to museums, religion and the arts leaves about 1% of the economy. Arnold Ventures, with assets of a little over $2 billion, gives about $400 million a year and has about 120 staff, far more than they ever expected.

• 09

  He focuses on changing systems

  They found that very few programmes rigorously work, and those that do (like K–12 schooling) are already funded by government. So they focus on changing rules and incentives. They merged their charitable (c3) and advocacy (c4) entities into an LLC, because the wall between them stopped experts from talking to legislators. That advocacy draws fire from both left and right.

• 10

  Criminal justice and drug prices are structural problems

  Bipartisan tough-on-crime laws responded to violent crime that rose after World War II and peaked in the late 80s and early 90s. Why crime then fell is still debated. About 95% of cases end in plea deals, so an innocent person facing a 20% chance of a 20-year sentence may plead. On drugs, Arnold says the US is about 5% of the world's population but pays about 50% of global pharmaceutical revenue, often 2–3 times other countries' prices, with healthcare at 15–17% of GDP.