Investo-Mania & Behavioral Pension Disorder
Drama. The investment industry is festooned with experts and consultants in “investment risk management” and no pension fund manager will buy a mutual fund or hedge fund, or fund of funds, without getting an opinion of what the expected “risk” might be; or what the expected “surprise” might be; or whether the “diversification” is effective (Institutional Investor, June 3, 2013, More Institutions Dispense With Hedge Funds As An Asset Class).
And they might say that if something goes wrong – and it will – that they did what they had to do and can’t be blamed. It wasn’t their fault but they ought to be sacked anyway because how is the fund sponsor or board supposed to account for the excess $200 million, or $2 billion, loss or gain to their constituency?
If a pension fund manager buys Real Return Bonds (RRBs) or Treasury Inflation Protected Securities (TIPS), then the only risk is “liquidity” and that’s not a risk either as long as the fund has adequate cash-in every year to meet the cash-out requirements.
Promises Kept, Promises Broken
by Jonathan R. Macey, Princeton University Press, 2008
But that’s the problem. Many of them don’t, and have made impressive promises that they don’t know how to keep, and they can calculate the time at which they won’t as the enrollment dwindles and the pensioners don’t die off fast enough, and, therefore, it is required that today’s investments will grow to meet the future demand for money, and they know that they need to seek out and embrace excess returns – also known as gambling.
As an example of profound thinking in “Pension Medicine” consider carefully: “The Employees Retirement System of Texas recently decided to integrate hedge fund investments across its entire $24.9 billion portfolio rather than keep them in a separate bucket. Already common among U.S. foundations and endowments, this practice is starting to gain traction with pension funds” (ibid, Institutional Investor).
Market Cling & Separation Disorder
What that means is that “hedge funds” will be treated as an “asset class” like equities and fixed income, and the “asset allocation model” has the market on one axis and investment funds and their liquidity profile on the other, and (the best part) U.S. equities could include not only old-fashioned stocks, but a long-short equity hedge fund, a long-only manager, an activist equity manager, and a private equity fund, for example.
But it gets better: “Take equity-oriented activist managers, which often don’t hedge or are not well hedged against the stock market; they deliver value by forcing changes in governance or strategy at portfolio companies. Their investment style makes more sense as part of an allocation that’s expected to rise and fall with the market. Activism is traditionally a long-only, low-leverage type of equity-centric investing that does not really fall into the absolute-return bucket. However, activist managers mesh well with public equity portfolios, in which they provide a different return stream than typical active equity funds” (ibid, Institutional Investor).
It’s Your Money. Get it Back.
We need to go back to first principles and dig in: an investment is just and only the purchase of risk, and like anything else that we might want to buy, we ought to know the price of it, that is, we ought to know the price of risk.
Thank You.
If the consultant can’t or won’t guarantee the capital – 100% capital safety – and a hopeful return above the rate of inflation, then it’s not an investment, and it won’t solve our pension problems, and we have really, really, cheap alternatives that do.
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.
Postscript
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”
Guaranteed
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 RiskWerk@gmail.com.Disclaimer 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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