Credit and Value Investors Have a Similar Outlook on Risk

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Credit and Value Investors Have a Similar Outlook on Risk
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In order to get more return, you have to take more risk, right?  Those of us who are value investors, or bond investors, have disagreed with this idea for years.  We get the best returns by avoiding risk.

Credit and Value Investors Have a Similar Outlook on Risk

A great part of of making money in investing is not losing money.  In order to avoid losing money, you have to buy assets that are cheap relative to their value, and intrinsically safe — i.e. what is the worst-case scenario?  Could I lose a lot if things go badly?

Blue Mountain Credit Fund still in the red YTD; here are their biggest holdings

Blue MountainBlue Mountain Credit Alternatives Fund was up 0.36% for November, although the fund remains well into the red for the year. For the first 11 months, the fund was down 24.85% gross. Q3 2020 hedge fund letters, conferences and more Blue Mountain's fundamental credit strategy was up 0.63% for November, including a 1.09% gain for Read More


This book is two things: it is a teardown of modern portfolio theory as posited by the academics, and the establishing of a new theory that suggests that we get better returns by avoiding volatility of investment returns.

Here’s part of the problem: Scientists are human, just like you and me, and they occasionally defend wrong ideas because they propagated in a time where some novel but wrong papers/books were written, and seemed right at the time, and the consensus accepted them, because it agreed with their biases.

That’s what happened with modern portfolio theory.  The bias of the economists was “You have to take more risk to get more return,” when the reality is that taking more risk to get more return works up to a point, and after that, those buying volatile stocks, bonds, etc., are trying to hit “home runs,” and have lost track of risk control.  People don’t estimate well in high volatility situations, and tend to lose money as a result.

Think of it this way: if you want to be totally safe, invest in cash-like instruments.  You will earn nothing.  If you want to make some money, invest in a portfolio of stocks or bonds that are stable in terms of their market returns.  If you want to lose money, invest in volatile investments.  Most investors will not know the right time to buy or sell those investments.  It is too hard; leave it to the fools that want to take long-shot bets.  Gamblers don’t win in investing.

Low volatility investing is a proxy for safety, but also a proxy for neglect.  Many companies dwell in the shadows of the market.  No one follows them.  They may be big enough to be followed, but they are in an uncool industry, like insurance.  Or they represent an out-of-favor area, where only insiders/experts are quietly playing.

This is a good book for two reasons: it tells you to avoid the idealistic theories of the academics.  Second, it tells you that avoiding risk/volatility leads to better returns.

Most successful businessmen are in the middle. They take prudent risks.  This book may do this from a quantitative investment framework, but that is what it encourages.

Quibbles

The book needed a better editor, but so do most books.  We need more grammar, spelling and typo Nazis.

Who would benefit from this book:   There is not much math in the book, but there is a lot of discussion of academic papers on finance.  If discussion of academic papers on finance bores you, this is not for you.  If you can tolerate that, this is a very useful book for those that want to do better in investing.  If you want to, you can buy it here: The Missing Risk Premium: Why Low Volatility Investing Works.

Full disclosure: The author sent me a Kindle copy of the book, without my asking.

If you enter Amazon through my site, and you buy anything, I get a small commission.  This is my main source of blog revenue.  I prefer this to a “tip jar” because I want you to get something you want, rather than merely giving me a tip.  Book reviews take time, particularly with the reading, which most book reviewers don’t do in full, and I typically do. (When I don’t, I mention that I scanned the book.  Also, I never use the data that the PR flacks send out.)

Most people buying at Amazon do not enter via a referring website.  Thus Amazon builds an extra 1-3% into the prices to all buyers to compensate for the commissions given to the minority that come through referring sites.  Whether you buy at Amazon directly or enter via my site, your prices don’t change.

By David Merkel, CFA of Aleph Blog

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David J. Merkel, CFA, FSA — 2010-present, I am working on setting up my own equity asset management shop, tentatively called Aleph Investments. It is possible that I might do a joint venture with someone else if we can do more together than separately. From 2008-2010, I was the Chief Economist and Director of Research of Finacorp Securities. I did a many things for Finacorp, mainly research and analysis on a wide variety of fixed income and equity securities, and trading strategies. Until 2007, I was a senior investment analyst at Hovde Capital, responsible for analysis and valuation of investment opportunities for the FIP funds, particularly of companies in the insurance industry. I also managed the internal profit sharing and charitable endowment monies of the firm. From 2003-2007, I was a leading commentator at the investment website RealMoney.com. Back in 2003, after several years of correspondence, James Cramer invited me to write for the site, and I wrote for RealMoney on equity and bond portfolio management, macroeconomics, derivatives, quantitative strategies, insurance issues, corporate governance, etc. My specialty is looking at the interlinkages in the markets in order to understand individual markets better. I no longer contribute to RealMoney; I scaled it back because my work duties have gotten larger, and I began this blog to develop a distinct voice with a wider distribution. After three-plus year of operation, I believe I have achieved that. Prior to joining Hovde in 2003, I managed corporate bonds for Dwight Asset Management. In 1998, I joined the Mount Washington Investment Group as the Mortgage Bond and Asset Liability manager after working with Provident Mutual, AIG and Pacific Standard Life. My background as a life actuary has given me a different perspective on investing. How do you earn money without taking undue risk? How do you convey ideas about investing while showing a proper level of uncertainty on the likelihood of success? How do the various markets fit together, telling us us a broader story than any single piece? These are the themes that I will deal with in this blog. I hold bachelor’s and master’s degrees from Johns Hopkins University. In my spare time, I take care of our eight children with my wonderful wife Ruth.

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