Beware of Black Swans Not Happening

• Posted by Adam Warner
• on August 24th, 2010

The uptrend in articles about the uptrend in desire to play for Black Swans continues to show no top. There’s this from the Journal.

After a decade-long bear market and two years of turmoil that saw the stock market plunge by 57%, investors are betting on still more financial pain in the months ahead.

Bond yields are near record lows. Gold continues to soar. And stocks are whipsawing as traders try to predict the direction of an economy that remains, in the words of Federal Reserve Chairman Ben Bernanke, “unusually uncertain.”

But not every investor is trembling with anxiety over the next financial blowup. Some are embracing the market’s volatility—and constructing portfolios to profit from it.

A growing number of money managers and financial firms are rolling out investment products designed to exploit big declines known as “black swan” events. Most of the products are geared toward institutional investors such as pension funds, endowments and high-net-worth families—but black-swan strategies are trickling down to Main Street as well.

So you, Joe Retail, want to profit hansomely from a Black Swan? Bill Gross has a deal for you!

Retail investors are getting more access to black-swan-oriented strategies, too. Bond-fund giant Pacific Investment Management Co., or Pimco, has recently begun using tail-risk strategies in its Pimco Global Multi-Asset Fund, which launched in October 2008; in its RealRetirement target-date funds; and in its new equity funds launched this year. The firm also has filed a registration statement with regulators to offer exclusive “private placement” investments to well-heeled investors using tail-risk hedging strategies.

But perhaps the best advice sits just 1 paragraph later.

Some individual investors even are considering setting up black-swan portfolios of their own. “The 2008 downturn got me thinking that black swans can happen and will happen,” says Justin McCurry of Raleigh, N.C. The 30-year-old transportation engineer says he is thinking of putting a small portion of his portfolio into options as a way to “limit downside or to pick up some extra money if things went crazy.”

My partner in sarcasm Josh Brown aka The Reformed Broker had some thoughts on this piece, would like to add a few here.

*The increasing demand for all things Tail and Black Swan and the ease with which anyone can slap on a play in and of itself makes another 2008 style meltdown exponentially less likely for the simple reason that way more people are primed and ready for it. Not to mention there’s no more Lehman or Bear Stearns to disappear into the ether.

*There’s a clearly a straight line between the popularity  of these new products and the skew on the options curve towards overpriced puts, as well as the steep term structure in the VIX curve (higher VIX as you go out in time).

*Joe Retail should really keep it simple, SPX or SPY puts accomplish essentially the same thing as some exotic sounding Black Swan product

 

 

The information in this blog post represents my own opinions and does not contain a recommendation for any particular security or investment. I or my affiliates may hold positions or other interests in securities mentioned in the Blog, please see my Disclaimer page for my full disclaimer.

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