From the constant stream of research that we review, I came across an interesting nugget yesterday from Investment News that caught my eye since it was expressed in sailing terms. The article was about “black swan*” events like the 2008 market and how some institutional investors are buying portfolio protection for that. The extract from the article reads:
Goldman Sachs strategists said last month that investors were overpaying for the derivatives as fears of a sovereign default in Europe became too extreme, and not paying enough to hedge against higher-probability scenarios such as a prolonged period of low growth that spares the financial system while causing a jump in defaults among the lowest-rated borrowers.
“To put it into sailing terms, investors are paying a high premium to hedge against a sudden storm,” Goldman Sachs strategist Alberto Gallo in New York said. “But they’re not willing to hedge against a prolonged period of no wind. This creates a buy opportunity for credit.”
We bring this to your attention because we believe our clients’ portfolios are appropriately positioned through our investment strategies to protect against BOTH a sudden storm and a prolonged period of no wind and at a reasonable cost.. The performance metrics contained in the 6/30/10 client statements seem to bear that out.
For much of the year before Lehman’s collapse, Nassim Nicholas Taleb warned bankers that they relied too much on probability models and had become blind to potential catastrophes, which he labeled black swans, a reference to the widely held belief that only white swans existed — until black ones were discovered in Australia in 1697. His 2007 book, “The Black Swan,” contends tail risks are becoming more severe.To hedge against tail risks, investors usually look for the cheapest insurance against a cataclysmic market sell-off, mainly through derivatives that are expected to multiply in value as prices plummet for everything from stocks to the Australian dollar.