Value Investor?

For a stock portfolio that is assembled based on "a normal bell curve", the negative fat tail of 2 or 3 SD can kill your portfolio too. Though you may think it is unlikely to happen, it may happen. It is just a matter of time. So anyone any suggestion how to hedge against this negative fat tail?
Am I talking nonsense? Any Guru?

(17-01-2015, 11:33 PM)Temperament Wrote: For a stock portfolio that is assembled based on "a normal bell curve", the negative fat tail of 2 or 3 SD can kill your portfolio too. Though you may think it is unlikely to happen, it may happen. It is just a matter of time. So anyone any suggestion how to hedge against this negative fat tail?

Look at the businesses you own, and look at their track record through business cycles. Can something serious or unexpected kill this business? That's something you have to ask yourself and explore deeply.

Next question would be - would this business still exist 10 years later, in more or less its present form? Would it still be able to grow steadily and generate high ROE/ROIC and FCF?

If more investors asked such questions, you'd greatly reduce the risk of an adverse event wiping you out.

And oh yes, avoid leverage of course.

(18-01-2015, 12:16 AM)Musicwhiz Wrote:

(17-01-2015, 11:33 PM)Temperament Wrote: For a stock portfolio that is assembled based on "a normal bell curve", the negative fat tail of 2 or 3 SD can kill your portfolio too. Though you may think it is unlikely to happen, it may happen. It is just a matter of time. So anyone any suggestion how to hedge against this negative fat tail?

Look at the businesses you own, and look at their track record through business cycles. Can something serious or unexpected kill this business? That's something you have to ask yourself and explore deeply.

Next question would be - would this business still exist 10 years later, in more or less its present form? Would it still be able to grow steadily and generate high ROE/ROIC and FCF?

If more investors asked such questions, you'd greatly reduce the risk of an adverse event wiping you out.

And oh yes, avoid leverage of course.

All that you said, makes sense. But can we buy some sort of hedge to cover this negative tail? Or innovate one ourself?

There is no hedge to cover if event belongs to the category of unknown unknowns.
The chances of it happening is actually higher than what most people think.
We can however, prepare for it. Keeping aside cash for a rainy day.
And also to know when to reduce and exit when fair value is reached, thus reducing the overall portfolio size.

This is what I did for U.S. financials recently. Sold a significant portion of it late last year as it reaches closer to its fair value. It has not reached its fair value yet and is likely to trend up within the foreseeable future and I did not need the money for anything else but I think it had to be done. I have traded away the unknown unknown risks with a bit of upside potential. I think this makes sense at this juncture.

(18-01-2015, 12:16 AM)Musicwhiz Wrote:

(17-01-2015, 11:33 PM)Temperament Wrote: For a stock portfolio that is assembled based on "a normal bell curve", the negative fat tail of 2 or 3 SD can kill your portfolio too. Though you may think it is unlikely to happen, it may happen. It is just a matter of time. So anyone any suggestion how to hedge against this negative fat tail?

Look at the businesses you own, and look at their track record through business cycles. Can something serious or unexpected kill this business? That's something you have to ask yourself and explore deeply.

Next question would be - would this business still exist 10 years later, in more or less its present form? Would it still be able to grow steadily and generate high ROE/ROIC and FCF?

If more investors asked such questions, you'd greatly reduce the risk of an adverse event wiping you out.

And oh yes, avoid leverage of course.

The MW's conservative approaches are good "hedges" for risks, but not including the unknown-unknown (black-swan event), or those 2D/3D events.

IMO, suitable diversification still a good mitigation for the unknown-unknown risks. What is "suitable"? It depends on the strategy used, e.g. lower diversification for qualitative strategy, and highly due to quantitative approach.

(19-01-2015, 12:54 AM)Big Toe Wrote: There is no hedge to cover if event belongs to the category of unknown unknowns.
The chances of it happening is actually higher than what most people think.
We can however, prepare for it. Keeping aside cash for a rainy day.
And also to know when to reduce and exit when fair value is reached, thus reducing the overall portfolio size.

This is what I did for U.S. financials recently. Sold a significant portion of it late last year as it reaches closer to its fair value. It has not reached its fair value yet and is likely to trend up within the foreseeable future and I did not need the money for anything else but I think it had to be done. I have traded away the unknown unknown risks with a bit of upside potential. I think this makes sense at this juncture.

Ah............
i like your reply. i always believe not to be pawed by the Bear is more important then catching the bull by it's horn. Less you may be caught by the Black Swan which may cause your stock portfolio to sing her(BS) swan song. (It may not if you really stick to your B & H for 20, 30 years.)
Never mind if i have left more money on the table more then i like. Why complain i have "everything" ready for the next hunting season, isn't it?
My style, my way. Your style your way. Black or white cat, does it really matter? Go and ask "Teng Xiao Peng"
Shalom.

Macro black swan events are taken care of by the managers of the business. That's why you must trust their track record.

I think Jack Ma got it right when he said first comes employees, second customers, third shareholders. People who run the biz are the ones that will make the difference.

The unknown-unknowns for stock pickers are stock specific rather than macro related for example fraud

(19-01-2015, 10:16 AM)specuvestor Wrote: Macro black swan events are taken care of by the managers of the business. That's why you must trust their track record.

I think Jack Ma got it right when he said first comes employees, second customers, third shareholders. People who run the biz are the ones that will make the difference.

The unknown-unknowns for stock pickers are stock specific rather than macro related for example fraud

Yes, agree. That make diversification worked. A "macro black swan" is a systemic risk, which will remains no matter the level of diversification.

That is to say if you are always in the market, "don't be surprised but prepared to be caught" by the Black Swan.
Anyway you can't do anything about the BS except diversification or get some cash out of the market would be best.

(19-01-2015, 10:16 AM)specuvestor Wrote: I think Jack Ma got it right when he said first comes employees, second customers, third shareholders. People who run the biz are the ones that will make the difference.

This is why I hate Jack Ma and his typical s-chip mentality. Always employees(he being biggest employee of all) first and that's why we as shareholders are getting screwed. Look at Alibaba structure n it will raise all kinds of red flags but no one cares just like there will always be suckers for s-chips.

To me to earn a corp respect is an MNC that I worked for in which it is clearly spelt out why the company exist and it is for 4 stakeholders and not in order of priority.

1. employees
2. business partners ( customers, suppliers etc)
3. shareholders
4. community ( CSR, charity work etc)

The job of management is to balance each of these. Yes sometimes you might have to retrench people and other times you have to listen to shareholders to restructure the company.

sorry OT a bit, Monday blues