photo of person holding ceramic mug

Risk Update – May 2021

One of our old sayings, dating back to pre-Asian Crisis days, is that when you have positively convex portfolio construction, “more risk is less risk”. We can put this many ways. It is not the forecast, but rather the payout that matters. It is not “x”, the uncontrollable outcome of the underlying, but rather f(x), your exposure to the outcome, that matters and that you can control. Back in our December 2020 update (https://convex-strategies.com/2021/01/22/risk-update-december-2020/) , we touched on this concept and used Jensen’s Inequality to visualize the differing payout functions of a Volatility Swap versus a Variance Swap. Figure 1:…

Risk Update – April 2021

A question we often get asked, as we discuss building convexity into investment portfolios with large Pension Funds/SWFs/Insurance Companies/Endowments/Banks, is something along the lines of “How much can we realistically do? Can we do enough to make a difference?”. The honest answer is plenty enough to make a major difference! In last month’s update https://convex-strategies.com/2021/04/16/risk-update-march-2021/ figures 10-17 showed the nearly identical concavity of a range of familiar investment strategies. We observe, regularly, how the near universal incentive around short-term arithmetic returns, conveniently paired with flawed risk methodologies, leads unsurprisingly to fiduciaries in all forms targeting the mean of short-term probabilistic…

Risk Update – March 2021

Not so long ago, there was a Federal Reserve Chairman by the name of Paul Volcker, who was preceded by William Miller and, before him, Arthur Burns. We will leave it to readers should they like to dig up and read the history of these gentlemen but suffice to say they were the chaps that had to deal with the initial aftermath of Nixon’s de-pegging of the USD from gold, which ushered in the post-Bretton Woods era of a pure fiat-based currency system. Burns and Miller presided over the greatest spike in CPI, thus far, in modern US history. CPI…

Risk Update – February 2021

Last month we touched on how the misrepresented risk underlying short positions in GameStop led to sufficient dislocations to feed through to a correlated impact on overall equity market volatility. Interestingly, we had a similar, if seemingly unrelated, incident at February month end as the grind higher in global interest rates triggered sufficient volatility to feed through to equity market volatility. Positively correlated movements in bond and equity prices, as well as volatilities, has, as we seem to endlessly discuss, potentially dire implications for a preponderance of portfolio management strategies and is what leads us to dub “rates can’t go…

Risk Update – January 2021

Like many of you, we could not help but have our attention grabbed by the activities in a previously little-known US stock by the name of GameStop. As most will be aware, it witnessed an epic short squeeze as, allegedly, retail investors sniffed out excessive hedge fund shorts and proceeded to exact significant punishment on them. Figure 1: GameStop (GME) Share Price Source: Bloomberg The news around the GameStop squeeze dominated market chatter in the last days of January, even rising to the lofty heights of being raised as an issue at the presser of Fed Chair Jay Powell. (https://www.reuters.com/article/us-usa-fed-powell-gamestop-idUKKBN29W32J)….

close up of coins

Risk Update – December 2020

Most of us are loosely familiar with what has been going on in the Venezuelan economy over recent years. Simply put, another in a long history of failed systems that tried to defend their position by debasing their currency. The below chart of USD/VES (the current revised version of the Venezuelan Bolivar) is what full-fledged hyper-inflation looks like. Few people would disagree with that statement. Figure 1: USD/VES Spot Rate Source: Bloomberg Likewise, the below chart of Bitcoin versus a debasing USD might be considered early-stage hyper-inflation. At the very least inflation. We like to think of this chart as…

calm body of lake between mountains

Risk Update – November 2020

Last month (https://convex-strategies.com/2020/11/19/risk-update-october-2020/) we referenced a speech from Federal Reserve Vice Chair of Supervision, Randall Quarles, and noted that we should expect to see further formal policy papers coming out on the topic of ongoing support of levered Non Bank Financial Institutions (NBFIs). Well, courtesy of the Financial Stability Board (FSB), here it is and she’s a beauty! https://www.fsb.org/wp-content/uploads/P171120-2.pdf The 60-page note has some useful timelines on the events preceding, during and following the pandemic related market shocks of Q1 this year. It is effectively a 60-page justification of moral hazard inducing behaviour by central banks, and even self-identifies as…

Risk Update – October 2020

https://uk.reuters.com/article/uk-cenbank-policy/central-bankers-seek-new-role-in-brave-new-world-idUKKBN27Q1M2 Just as we were putting together our thoughts for this month’s update, we came across the above linked article which is such a good example of the misunderstanding of fragility, our chosen topic for the month. It is a Reuters article, but we might classify it as a “Not the Onion” or “Not the Bee” type article. The opening line reads: “Taking a break from fighting the coronavirus crisis, the world’s top central bankers will attempt to resolve the existential questions of their profession this week as they tune into the European Central Bank’s annual policy symposium.” We are…

Risk Update – September 2020

https://www.institutionalinvestor.com/article/b1nhg4w9k5hjp0/Nassim-Taleb-and-Universa-Versus-the-World Above is a link to an entertaining little note which echoes conversations that we have every single day, including past ones with the very antagonist of the story. Our experience in said discussion would lead us to agree with the comment in the article that “Meng, like many finance professionals, also never understood tail hedging”. We have a certain degree of empathy to the concept of it being us versus the world. We talk about it over and over, it is geometric compounding that matters to the end capital owner. The two relevant ingredients, in a recipe to maximize…

Risk Update – August 2020

“The Federal Open Market Committee (FOMC) is firmly committed to fulfilling its statutory mandate from the Congress of promoting maximum employment, stable prices, and moderate long-term interest rates. The Committee seeks to explain its monetary policy decisions to the public as clearly as possible. Such clarity facilitates well-informed decision making by households and businesses, reduces economic and financial uncertainty, increases the effectiveness of monetary policy, and enhances transparency and accountability, which are essential in a democratic society.” (bold highlights added by us) https://www.federalreserve.gov/monetarypolicy/files/FOMC_LongerRunGoals.pdf So reads the opening paragraph to the “Statement on Longer-Run Goals and Monetary Policy Strategy”. The original…