James Montier (hat tip Cullen Roche) has a paper out on tail risk with some ideas on how to protect against it and a bit of a warning about the saturation of products now at investors' disposal. While not necessarily the focus of my post I would point out that Montier rightfully places a lot of importance making sure you know what tail risk you are hedging against. For example, if your primary concern is hyperinflation then you don't want to load up on TLT or a bunch of long bonds.
I like that Montier is skeptical about all the "tail risk" products, even the fund that Nassim Taleb advises may come out with a black swan ETF. I generally believe in trying to protect portfolios against large declines in the market. In the past this has included cash (raised from selling some positions), inverse index funds and market neutral/absolute return funds. Where the market neutral/absolute return funds are concerned I have sought out what I believe to be relatively simple products.
Montier points out the utility of cash in this context. In terms of incorrect positioning too much long exposure is worse than too much cash. People often get impatient holding cash although I think they become more accepting when they see the market endure a large decline while they have a large cash position.
It would be great to be correct with every decision, all in or all out. As this is not possible the question becomes what is possible or reasonable? Obviously heeding something like a breach of the 200 DMA requires no ability to correctly assess what is happening, just recognize that something is happening. Heeding the 200 DMA in late 2007 by raising cash would have obviously avoided a lot of pain. While some profited one way or another from the declines that ensued in the financial crisis, I think avoiding most of it would have been a great outcome.
It would have been those folks with the ability to analyze what was going on, IE pick the correct tail, who profited. These folks could have used various complicated products (and a few simple one) to benefit from the decline but it doesn't get much simpler than cash and simple cash, as proactive tool, can be very effective.
Very few of us are going to be the guy who makes $1 billion correctly shorting the next crisis. But many of us can raise cash based on some objective trigger point and avoid a meaningful portion of the next crisis.
Proud Member Of
Random Roger
© 2009 | Gadget Theme Blogger Template
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
Original WPtheme By Blogger Template | Converted By Gadget Lover
| Distributed by eFree Blogger Help
12 comments:
If one is truly a long term investor, trying to protect purchasing power, a large cash position as an asset class doesn't make sense to me.
If one is truly a long term investor, trying to protect purchasing power, a large cash position as an asset class doesn't make sense to me
What if 'cash' had been earning a 4.5% real (after inflation) return between 1983 and 2010 inclusive?
That's what investors could have been earning in a risk free manner, albeit not instant access (i.e. 5 year treasury ladder).
Roger, did you receive my email?
Sam
Sam, I don't think I did. Is Sam your real first name?
No. I used your firm's email to establish contact. Do you have another posted email address?
rnusbaum@ysfi.com
I sent the email to this address.
OK.
Sam
Clive, stocks as represented by the S&P 500 from 1983 through 2010 returned 11% per year, inflation averaged 2.9% over that time. I'll take a diversified portfolio of equities with an eye toward value and increasing dividend payouts, and learn to deal with the volatility, which has always been the freight to pay.
Today the 10 year has a PE of 33x, similar to large cap safe stock valuations in 2000. Remeber PFE, GE, HD etc. during the top of 2000? all 30x +. It took a decade of these stocks to grow into their excessive valuations through a combination of increased earnings and decreased share price. I think that today, bonds are in the same boat.
A big difference however is that of capital preservation. If each treasury ladder rung is bought with a coupon yield much the same as the then market rate/yield, the bond will mature at/close to the purchase price - (almost) guaranteed. That might then roll into a higher yield (next 5 year T). Such that the ladder tracks rates up and down, albeit in a delayed like manner. For a 5 year ladder its cash like risk (but taking up to 5 years to fully roll out), 2.5 year average maturity volatility, 5 year average yield/reward.
I'll take a diversified portfolio of equities with an eye toward value and increasing dividend payouts, and learn to deal with the volatility, which has always been the freight to pay.
Not always. Wall Street Crash saw stock prices halve, halve again and halve yet again over a range of years. Japan endured a similar event starting in 1990 and still have stock prices a fraction of their 1990 levels. Who is to say we're not part way through such a sequence and in having endured one sizeable down step, might yet see another halving or two - hitting both dividend and capital values harshly.
Clive,
The numbers don't lie. Equities have given investors superior returns to bonds, cash and other asset classes over the long term, especially when factoring dividends. I don't understand the half, half and half again comment of yours regarding the market. One would have avoided a meaningful amount of past market decreases by paying attention to valuation, ( you wouldn't have bit on tech in 2000, nor GE selling at 40x), and you would not have been shaken out of your portfolio in 2008-09 selling at 5x yielding north of 6%. Short term pain is the price you have to pay, as there is no free lunch in holding equities long term. I am also assuming that one would have a sufficient liquid emergency funds, and low manageble debt level which would lesson the emotional tug of hitting the sell button.
The fundamental tailwinds for bonds are over. from 1982-2010 the 5 year US Treasury yield decreased from 15% to 1.5%. A bond investor tailwind for 28 years. You don't have that anymore. A look back at 1994 shows what happens in an increasing interest rate enviroment to a bond portfolio. Not pretty.
If you are laddering today 5 years, and are happy with 1.5% on the five year tranche, you must not be worried about inflation or purchasing power.
High to low base rate tail wind also applies to stocks.
If rather than religiously buying the 5 year as each ladder rung matures, you instead buy whatever was yielding the most out of 6 month to 5 year at the time, then you're in effect buying value (same yield for a lower price or higher yield for the same price). That plays the yield curve whilst doing so in a low risk manner and typically yields a real reward that is evident over both high to low and low to high base rate transition periods. Just not to such a great extent during low to high base rate transitions as during high to low base rate transitions.
I'm not suggesting using a treasury ladder alone, but rather that you might be better positioned with a range of assets of which one part might be a ladder. 'Cash' preserved at even 0% real makes an effective gain if later that cash then buys stock at half the original share price.
If stocks make a 8% real with high to low base rate transition tailwind and 'cash' makes 4%, then a 50-50 blend averages 6% real - still not too bad.
If during a low to high base rate transition stocks make 4% real and cash 0% real, then a a 50-50 still achieves a 2% real average.
Over the full cycle stocks might yield 6% compared to 50-50 4% real. But with the all stock approach you endure twice the volatility and a greater risk of buying the highs, selling the lows - which could result in far poorer overall performance. A 50-50 rebalanced back to equal weightings periodically is both more comfortable and more likely to add-low/reduce-high.
Again however I'm not suggesting that 50-50 is the best choice, but just selected that for demonstrative purposes only.
Post a Comment