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(30-07-2017, 04:20 PM)Temperament Wrote: 2011 James Montier on tail risk
i admit i don't really comprehend completely what he is saying.(Aka my maths is too elementary).
i only understand he favours cash as tail risk hedge.
And i think WB calls cash as option without expiry date.
i only have to understand what WB said and try to put into practice when i think the time is suitable.
If i am wrong, i only lose abit to inflation lol.
Capital still is intact is the most impotant to me.
It is then possible for me to see what i can do next.
Wanted to get a bit technical here for accuracy. Technically a hedge for an asset is an instrument that falls when the asset rises and vice versa. A hedge is a perfect hedge when it tracks the underlying asset exactly but negatively, and is a imperfect, or risky hedge when it doesn't do it perfectly. Usually, a perfect hedge is of no use, you might as well sell the asset. So, when people talk about hedges, they usually mean risky hedges. A basis hedge is when your hedge asset roughly tracks your underlying asset, but has the risk of something else going wrong.
By this definition, cash or holding SGS bonds (which someone else mentioned), is not a hedge. It is merely a diversifier. If your diversifier is good, hopefully, it holds its value when other parts of your portfolio is going down. You can then realize the diversifier to buy assets on the cheap (rebalancing). But it is not a hedge. In a tail risk scenario, it has been known to hit most assets. Even cash is not entirely safe in a tail risk situation - it depends on where you keep your cash (banks and money market funds have been known to fail), and the value of your currency (for example the Indonesian Rupiah during the Asian Financial Crisis).
Holding a short S&P position is a risky basis hedge for SGD investors who are mostly on the SGX. It presumes that the SGX stocks and the S&P are highly correlated, and needs to take into account the USDSGD exchange rate. But as a tail risk hedge (when you presume stocks everywhere are heading down), it might be acceptable. Holding a short STI index futures position is a partial hedge for someone holding a STI ETF (partial because you need to roll the futures position eventually) and is a basis hedge for someone who also holds non STI component stocks.
Holding a VIX position is a partial hedge on the S&P500. It is also a non-linear hedge (meaning the degree it covers the S&P500 will vary).
Lastly, all hedges have costs. A short position has funding costs. A position in a VIX futures contract has (big) time decay costs (due to the VIX depending on the S&P option basket and on the futures roll and other issues). A long put or call option has time decay costs (you pay a premium and lose that premium at option expiry if it is not in the money).
Nothing is perfect. But there are choices of cheaper or more expensive hedges. Risky or less risky. Short term, or long term.
