Each Sunday I compose a list containing the most thought-provoking and interesting content I’ve consumed during the past week. Primarily as a way to keep inventory of material that influenced me and my way of thinking.
Papers/Notes
Common Hedging Discussions Part 2: Tail Hedging Return Myths Debunked (2022) by QVR Advisors.
”. . . the stand-alone returns of one component of a portfolio does not provide enough information to judge the contribution of that component to the overall portfolio.”
”The impact of tail hedges on an asset pool’s long-term compound rate of return depends on the weight of equity and equity-like risk assets in the portfolio. In the last few years, the forward-looking returns on fixed income exposures fell with low or negative real yields, rising inflation and prospective interest rate hikes. In response, many asset owners are cutting fixed income allocations in favor of larger private equity and venture capital exposures. Many large institutional portfolios are nowhere close to 60/40 anymore. The more equity-oriented an asset allocation is, the more powerful the portfolio benefits of hedges.”
”. . . volatility selling strategies as equity replacement offer some path diversification, but not outright risk reduction in all types of paths. An option selling strategy is not inherently risk-reducing: a cash-secured put selling strategy has the same exposure as outright equities in a sharp market selloff. Option selling strategies are short convexity (loses money at a faster rate the worse things get), not long convexity like a tail hedge. As a result, while they may make money over time on a standalone basis, they are potentially less additive from an overall portfolio perspective to an already equity-heavy asset allocation.”
”For tail hedges specifically, it may make sense to have explicit rebalancing or monetization triggers based on market moves and not just the passage of time. The key here is in striking the right balance between the desire to capture gains and the need to deliver outsized performance in times of crisis. Tail hedges are by nature highly convex, providing much more incremental benefit when equities fall to – 30% below the highs from –20% below versus when they fall the first 10% from the highs. And the contribution of tail hedges to long-term portfolio performance comes from delivering outsized gains when core portfolios are getting wrecked. So, selling those hedges too early is self-defeating.”
”1) Market-conditions-based monetization strategies should be incremental based on a ladder of triggers, rather than binary. 2) Monetization strategies should be simple enough to track easily but also price dependent. There are scenarios in which markets are very stressed, but option prices have not risen enough to be very expensive relative to extreme realized volatility. . . . In other cases, option prices may have risen very excessively relative to the equity market selloff, and it is better to sell the core hedge positions. 3) Ideally, monetization strategies should be framed in advance to coordinate expectations and mitigate behavioral biases. . . . managers and clients should be on the same page about the expected approach to monetization and triggers set out in advance should raise decision points. Otherwise, it is too easy to act like a deer gazing into headlights.”
”. . . in practice there is a tradeoff between expected returns and covariances – hedges should generally have negative expected return, and in perfectly efficient, perfect-information academic markets, it would all be priced in. But what we are trying to illustrate here is simply that negative expected returns on a stand-alone basis does not imply negative contribution to overall portfolio compound rate of return; similarly, positive expected returns on a stand-alone basis does not imply positive contribution. How efficient a tail hedging strategy might be in augmenting long-term asset allocation is an empirical question and a question about market pricing and flows.”
Even if you already are a balls to the wall believer in the positive portfolio effect of assets with a standalone negative EV this note offers indispensable insight on how to think about monetization. See also Monetization Matters: Active Tail Risk Management and the Great Virus Crisis (2020) by Vineer Bhansali.
March 2022 Newsletter: Global Bifurcation by Lyn Alden.
”Companies basically traded away resilience in favor of efficiency, while pretending that there was minimal downside, and yet this type of approach only works under a benign global environment. Outside of the Middle East and a few localized regions around the world, the 1980s through the 2010s was generally a period of limited war as far as supply chains were concerned, with significant global openness and cooperation. Extremely efficient and highly complex supply chains, with limited redundancy or inventory, could thrive in this stars-aligned macro environment. Any company not playing that game would be less efficient in this environment, and thus would be out-competed.”
Writings/Essays
John Mearsheimer and the Dark Origins of Realism by Adam Tooze.
”It drives home the point that adopting a realistic approach towards the world does not consist in always reaching for a well-worn toolkit of timeless verities, nor does it consist in affecting a hard-boiled attitude so as to inoculate oneself forever against liberal enthusiasm. Realism, taken seriously, entails a never-ending cognitive and emotional challenge. It involves a minute-by-minute struggle to understand a complex and constantly evolving world, in which we are ourselves immersed, a world that we can, to a degree, influence and change, but which constantly challenges our categories and the definitions of our interests. And in that struggle for realism – the never-ending task of sensibly defining interests and pursuing them as best we can – to resort to war, by any side, should be acknowledged for what it is. It should not be normalised as the logical and obvious reaction to given circumstances, but recognised as a radical and perilous act, fraught with moral consequences. Any thinker or politician too callous or shallow to face that stark reality, should be judged accordingly.”
How Religious Faith Can Shape Success In School by Ilana M. Horwitz.
”Why does religion give boys like John an academic advantage? Because it offers them the social capital that affluent teenagers can get elsewhere. Religious communities keep families rooted to a place and help kids develop trusting relationships with youth ministers and friends’ parents who share a common outlook on life. Collectively, these adults encourage teenagers to follow the rules and avoid antisocial behaviors.”
You Actually Should Do Something That Scares You Every Day by Ryan Holiday.
Hidden Forces of Radical Hope by Tom Morgan.
Podcasts/Conversations
The Ethics of Autonomous Vehicles with Bryant Walker Smith, Complexity by the Santa Fe Institute.
Quantifying Structural Risk in ‘Zombified’ Markets with Hari Krishnan & Ash Bennington, Hidden Forces.
Pierre Andurand on How We Might Get $200 a Barrel Oil, Odd Lots.
Is ApeCoin a Sound Investment?, Pirates of Finance.
Long vol, short prediction models 