An interesting concept came up on the Consuelo Mack Show over the weekend from Nassim Taleb who wrote the book The Black Swan.
Based on the interview he is very risk adverse and said he doesn't really understand the stock market. I don't know enough about him to know if he is simply being modest.
He said that diversification used to work before people knew about diversification but now it doesn't work because people now know. He is certainly right when it comes to brief declines like we had last week.
His idea for portfolio construction is to put 90% into t-bills from various countries and then with the other 10%, the amount you can stand to lose, you should just let 'er rip. Just go hog wild.
I first heard about this concept, with a different twist, quite a few years ago. The idea as I heard it then while that market was falling was 98% t-bills and 2% short Nikkie futures. The idea is interesting from an academic standpoint, or I should say was interesting as the Nikkei is not quite the one trade it used to be.
I view Taleb's idea as being in that ballpark. The t-bill portfolio might average a 5% yield, which on $90,000 would be $4500 and obviously 4.5% to the entire portfolio. If, and I am conceding this is a big if, the $10,000 which is invested very aggressively could return 50% that would be $5000 which is obviously 5% to the overall pie and the total return in my example would be 9.5% which is almost what the stock market averages with much less risk. So it is interesting.
I see some complications that need to be considered. The first one of course is that the 10% that is aggressively invested could do very badly and so the overall return would be less than that 9.5%. Along the same lines if the 10% averages a beta of 2.00, that is kind of like a 20% exposure, in a manner of speaking.
The other big potential risk is that the dollar goes up against the currencies held in the t-bill portion. Sometimes currency moves can be very large, especially in the context of this being a "riskless" portfolio.
I find exploring topics like this very instructive in trying to learn more about portfolio construction and effects that can be created.
On a separate note we had a little fire here on the mountain yesterday. We have had a lot of thunderstorms lately and the fire was caused by lightening striking a tree. This was the second time I fought a fire in the pouring rain. Rain tends to prevent fire from spreading but doesn't necessarily put it out. It took about three hours which is not long for the typical wildfire but seems a tad long to spray, cut down and again spray a tree, oh well.
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21 comments:
roger, when I go to post a comment, in lower right hand corner of my screen it shows
"www.blogger.com" with a lock icon next to it....
my browser has had trouble lately,but is there an attmept to lock me out?
I am not sure exactly what you are seeing but I have not changed the comment policy at all.
I can say that there seem to be temporary browser compatibility issues that come up for FireFox all the time and so must happen with other browsers too.
What ever the issue, it is likely to clear up on its own, at least all the others have in the past.
I think it's very reasonable to conclude that diversifying one's portfolio has less benefit now than it did in the past. Diversifying still makes sense but the most things appear very highly correlated at this point.
Maybe owning individual stocks, like Roger advocates instead of funds or indexes, in other countries provides better diversification.
oh, wait I see that too.
no not an attempt to lock anyone out. it might be because I have the anti-spam thing that you have to type?
Don't really agree with the notion that "diversification used to work before people knew about diversification" -- there are so many ways to diversify and probably even more ways to do so ineffectively -- but it does seem true that when markets head south the correlations in many diversification schemes seem to go up and that's certainly not desirable either.
I may experiment with the idea on a smallish scale though, maybe using JGT as the 90%; now what would should the 10%'er be?
OT, we got the oversold bounce in equities but the credit markets are so badly roiled I'm not sure it will hold or, if it does, if it's setting up for something far worse later; feels very much like 1998 to me right now.
The concept of 90 - 10 is old. See "The Battle for Investment Survival" by Gerald M Loeb where speculating with 10% of your capital is, pursuant to this famous stock broker, the best approach to the market.
1998? Which part, LTCM, Russia's default, both, neither?
If that turns out to be correct, the entire round trip was about six weeks, if I am remembering correctly, i'll look that up a little later and maybe post on something related.
Sorry if I wasn't clear, I didn't think 90/10 was new but might be new to some folks.
Did anyone ever look at Acorn's Thermostat oef? In theory, I love this but not sure how to evaluate its results. Designed by Ralph Wanger of Acorn fame, it moves some assets out of equities into bonds when equities are getting overheated, and vice versa in tougher times for equities. Timing used to smoothe the ride. Aim is to do better than bonds but lag equities. I get their quarterly report and think that they are improving their approach with better diversification and more use of foreign assets. For myself, FCO looks like an interesting vehicle to allocate short term global bonds on a waxing and wanning basis.
ps..thx for your response, yes, i am a firefox user. i'm wondering if I am having problems with java, too, as I can not install their latest version. Great blog, hate not keeping in touch.
now you are talking
use a small percentage of your portfolio on leveraged futures with prudent stops and let it rip
=)
it's really the prudent thing to do
peace
Roger, substitute hedge fund and lender blowups for LTCM and the MBS/CDO defaults for Russia (these are an order of magnitude larger in nominal value than 1998); equity leadership (breadth) is narrowing and divergences are growing; e.g., 1998 was sometimes referred to as a stealth bear for the same reason.
Not saying it will _be_ 1998 of course; no point in making predictions as my crystal ball basically sucks.
In any case on the current credit front it looks like the blowups are coming faster and higher and more of them seem related to margin calls (gut check for creditors); e.g., American Home Mortgage (ACH) is now in serious trouble and, unlike New Century, we are not talking subprime here, it's conventional conforming, FHA/VA, prime jumbo, etc.
It's not just repricing of risk per se IMO, it's acknowledgment that uncertainty is greater than realized and, in the absence of the ability to accurately assess risk level, it is better to CYA and live to fight another day.
I've just finished reading The Black Swan and think you may misunderstand Taleb's perception of risk. The idea behind the book (and his other title Fooled by Randomness) is that history, technology, the markets, etc. generally don't move in steady increments, rather progress is marked by unforeseen, unpredictable events that can have cataclysmic repercussions. Coincident with that idea is his thesis that we tend to think we know more than we actually do and we tend to invent narratives for market moves that really aren't accurate. I wouldn't call him risk averse, I'd call him risk aware.
He is a former Bear Stearns trader, has managed a hedge fund and is currently in the process of launching a new hedge fund. Him saying that he doesn't really understand the market is him saying that nobody understands the market because of the random nature of events that influence the market. It's really an interesting read.
anonymous, the lock is your browser telling you that you are at a secure site (notice that when you post a comment the internet address starts with https: instead of http:). The www.blogger.com next to the lock tells you what site the security certificate is from. Conversely if you were at an https: site and the icon was of an unlocked padlock (or the site listed next to the padlock is not the site you think you are at) that would tell you that the security certificate is not valid and you probably should not enter personal information there.
Short answer, it doesn't matter for posting an anonymous comment on blogger.
I may misunderstand his perception of risk? I doubt I know any of it beyond what he said this weekend. The entire post was based on his comments on Connie's show that I saw on Sunday.
"I may misunderstand his perception of risk? I doubt I know any of it beyond what he said this weekend."
Exactly, which is why I'm pointing out that the glimpse you saw in the interview may have lead you to erroneously characterize him as 'very risk adverse.'
Clearly, defining degrees of risk tolerance is a highly subjective exercise, I'm sure we agree on that. However, the aim of his portfolio design (as I read it) is to produce outsize - much bigger than 50% annual returns - if major, market jolting events occur. If they don't, the portfolio steadily (albeit slowly) erodes. Since he knows he can't predict or time these events, he keeps most of his powder dry to enable him to stay alive until they do. As I recall from the book, it was this type of strategy that allowed him to essentially retire after the crash of 10/87.
You may see this as very risk averse. I see it as risk tolerant, but loss averse.
maybe so but if you saw the show i quoted him verbatim.
So basically you invest 90% of your money in risk free returns, the remaining 10% in lottery tickets and hope you get lucky?
(lottery tickets meaning things like superhigh risk "investments." Ex: far out the money calls or puts.)
I'm not familiar with this gentleman nor his book, but I think most of us are unlikely to follow his approach out the window. Perhaps the larger issue it raises, though, is how to add alpha to an otherwise diversified and balanced portfolio. My left brain loves MPT and the so-called lazy porfolios that grow out of the science. My right brain thinks I can be smarter than that by learning from sites like this one. I compromise with a set of core investments, protected with loose stops, that I rebalance when necessary. I keep 10% aside for trades that I believe will help me to outperform the benchmarks. I'm not speculating as some of these authors suggest, bit I am enjoying an early retirement.
Consuelo asked him that. She asked about biotech and tech and he said yes. I might also add oil sands and uranium companies that are still in the exploration phase. Things like that. OTM options did not come up.
to the 4:39 comment.
that is exactly the reason for the post. to simply explore other ways of assembling portfolios.
you nailed it on the head
Rather than leveraged futures with prudent stops, options are even better.
But, what's this about the demise of diversification? Someone ought to tell this to the nation's small town brokerage houses. Get on the phone and call any 20 of them, and mostly what you hear is diversification, diversification, diversification.
--Jack Payne
The problem isn't 'intending' to be diversified, it's actually having a diversified portfolio. My frustration with the brokerage community (speaking as a community member) is how completely we have bought into the Morningstar style box tout of owning nine types of stocks and selling that as a diversified approach to investing...
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