Tuesday, April 28, 2015

worried about the downside?

In a paper entitled “Worried About the Downside?”, Richard Bernstein did a fascinating analysis of asset classes tracking how each did in both an upside (bull market) and downside (bear market) environment. His findings were a real eye-opener. First, very few asset classes actually provide downside protection. His research shows most asset classes capture both the upside and downside of bull and bear markets. Second, only long-term US treasuries had a negative correlation – meaning they lost value in a bull market but gained in a bear market. Last, hedge funds – named because of their capabilities – actually aren’t very good hedges against a bear market.

So what has been Wall Street’s answer to these findings? In typical form they have developed a plethora of high cost strategies that include Constant Proportion Portfolio Insurance (CPPI), Volatility Cap Strategies, Volatility Options (VIX Options), Third Party Indices, Variance Swaps, Put Options, Dynamic Asset Allocation Hedging, and something called Interest Rate Swaptions.

Frankly, we are at a loss to describe what these strategies are doing, let alone how they function. We believe Wall Street in general is looking at market corrections and downside protection in exactly the wrong way. At Nintai we see market corrections more as an opportunity than an event to fear. As long-term investors, what could be better than to invest in great companies at a cheaper price? We strongly believe it is far better to be value oriented and use the correction as an opportunity, than spend high amounts of dollars attempting to avoid what might be your best investing prospects in years.

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