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The Smart Funds

May 26, 2013

Drama. The Smart Funds are investments that are likely to provide a non-negative real rate of return, that is, a return above the rate of inflation, and they tend to have just three properties, and they have all three: (1) they are risk-averse; (2) they tend to be illiquid; and (3) they rely on arbitrage which may be the result of a fact, an insight, or a crime. Naturally, anything else that lacks one or more of these properties, is a “Dumb Fund”, by definition, and we’ll look at some of those later in this Post.

As an example, The Perpetual Bond™ is a “Smart Fund”; it is provably risk averse; it tends to be illiquid because the equities in it are typically held for a long time, although they can also be sold in the open market if cash is required; and it depends on arbitrage due to a fact, which might be an insight, but is certainly not a crime:

The Perpetual Bond
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
With No Fees and No Loads on Capital

In our view, the “key” to “risk aversion” is always “arbitrage”, which is, basically, buying an investment (or thing) in one market that does not know the price of the same investment (or thing) in another (and the future usually has nothing to do with it, unless we know it for sure).

In the case of the Perpetual Bond™ the arbitrage opportunity is to buy and hold only those stocks (or investments) that are trading at or above the “price of risk”; and the markets that we’re arbitraging, so to speak, are the markets that are populated by “risk averse” investors as opposed to “risk seeking” investors, and we need them both. Please see, for example, our recent Post, Bystanders & Collateral Damage, April 2013, and the references therein:

In our view, there are only three types of investors: “risk seeking” investors who are willing and can afford to accept a possibly negative real rate of return in the hope of excess real rates of return, that is, above the rate of inflation; and “risk averse” investors who also hope for a positive real rate of return but will not or cannot accept a negative one, and are aware of that; and the others, those who are proactively neither “risk seeking” nor “risk averse” and may be called “gamblers”, or “reckless”, because they don’t really know what they want and will take what they get, even if it ruins them.

There are many other examples of “Smart Funds” and they all depend on arbitrage and an “insight” consistently applied by a “personality” that belongs to a person (naturally); however, there are no mutual funds, index funds, or hedge funds, that are “Smart Funds”, even though some of them might have made a lot of money, because in one way or another, and sometimes all three, they don’t have those properties.

We raise the issue because we are overwhelmed at the number of offers that we get to buy this, or buy that, and make money or at least keep our money safe against the “ravages of inflation”. So we developed this simple but “Acid Test” (pink or blue, so to speak) that if the offer disrespects any of the three properties, (1), (2), or (3) above, it’s just a gamble and no less compelling than to buy a lottery ticket (which, admittedly, is still attractive to a lot of people, and we don’t have anything to say about that, other than, it’s a gamble).

Mutual funds and Index funds fail the test because none of them guarantee the capital even though they all hold out the possibility of obtaining, over time, a long time, a rate of return that might exceed the rate of inflation (although they have no idea what that will be).

The insurance company segregated funds also fail the test; they guarantee the capital, and hold out the possibility of a non-negative rate of return, but the history of the last twenty years has been that the insurance companies are going broke just trying to guarantee the capital of their segregated funds, let alone their own funds. Please see our recent Post, (B)(N) MFC Manulife Financial Corporation, May 2013, for some insight into that (notwithstanding the even more legendary, AIG American International Group Incorporated).

Fast trading technologies, such as micro-arbitrage, have Property (3) arbitrage and fact, but fail to have Properties (1) and (2) because they are very expensive (capital intensive) to implement, and even more expensive to maintain an edge, and we might end up with just a lot of rust and old “iron” at any time, or when our lease runs out.

The Capital Assets Pricing Model (CAPM) and Modern Portfolio Theory (MPT) are also trading models implemented by computers and programs, and they run more or less automatically around the clock and around the world, and do some of all three; (1) they know the word “risk aversion”, but don’t know how to implement it other than by past observed volatility measurements; (2) they are illiquid as 40%/60% or 60%/40%, all of the time, but one can get cash out of them by selling something and re-balancing; and (3) they would be correct (an insight) if there was no arbitrage in the World and the World was jointly and covariantly log-normally distributed.

Finally, we get to the “Hedge Funds” of which we have said a lot in these Posts, and they usually fail the test for reasons of liquidity and a failure to demonstrate capital safety; both questions important to ask if a hedge fund should come our way.

JusticeBut today at least one of them may demonstrate the Property (3) and we can refer to no less an authority than The Wall Street Journal, May 23, 2013, Four Top SAC Executives Receive Subpoenas in Probe, which is more eloquent than we could ever be, one would think.

The Price of Risk

The calculated Risk Price (SF) is a provably effective estimate of the “price of risk” which is “the least stock price at which the company is likeable” (Goetze 2009) and “likeability” is determined by the demonstrated factors of “risk aversion” – we want to keep our money and obtain a hopeful return above the rate of inflation – and the properties of portfolios of such stocks.

Stock prices that are less than the price of risk can be said to be “bargain prices” but with the risk attached that the company might never get a higher price other than that due to ambient volatility or “surprise”; on the other hand, investors who are willing to pay the “full price” above the price of risk, and buy and hold the stock at those prices, must also be confident, and have reason to believe, that the company will produce those values, absent new information.

Please see our Posts, The Price of Risk, August 2012 and The Nash Equilibrium & Its Stock Price, October 2012, for more information on the theory.

To see what else “risk averse” investing can do for us, please see our recent Posts, The Wall Street Put, April 2013, and earlier Posts such as The Dow Transports, March 2013, or The Risk Adjusted Dow, March 2013, or The Canada Pension Bond, February 2013, and for a more colorful description of investment risk and the application of the “price of risk” to mergers & acquisitions, please see our Post, Bystanders & Collateral Damage, April 2013.


We are The RiskWerk Company and care not a jot for mutual funds, hedge funds, “alternative investments”, the “risk/reward equation” and every other unprovable artifact of investment lore. We have just one product

The Perpetual Bond
“Alpha-smart with 100% Capital Safety and 100% Liquidity”
With No Fees and No Loads on Capital

For more information on RiskWerk, please follow the Tags or Categories attached to this Letter or simply enter Search for additional references to any term that we have used. Related data may be obtained from us for free in a machine readable format by request to


Investing in the bond and stock markets has become a highly regulated and litigious industry but despite that, there remains only one effective rule and that is caveat emptor or “buyer beware”. Nothing that we say should be construed by any person as advice or a recommendation to buy, sell, hold or avoid the common stock or bonds of any public company at any time for any purpose. That is the law and we fully support and respect that law and regulation in every jurisdiction without exception and without qualification to the best of our knowledge and ability. We can only tell you what we do and why we do it or have done it and we know nothing at all about the future or the future of stock prices of any company nor why they are what they are, now. The author retains all copyrights to his works in this blog and on this website. The Perpetual Bond®™ is a registered trademark and patented technology of The RiskWerk Company and RiskWerk Limited (“Company”) . The Canada Pension Bond®™ and The Medina Bond®™ are registered trademarks or trademarks of the Company as are the words and phrases “Alpha-smart”, “100% Capital Safety”, “100% Liquidity”, ”price of risk”, “risk price”, and the symbols “(B)”, “(N)” and N*.

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