During our October 21st Office Hour session, we interviewed long-time Framework member and partner, Sheila Chesney, about her trip to attend the Fall 2017 Grant’s Investment Conference at the Plaza Hotel in New York City.
We posted a series of videos of that interview here, in the Archived Webinars section of the site, but there was one Grant’s speaker whose work we wanted to point out particularly: Frank Brosens, co-founder of Taconic Capital and former Goldman Sachs managing director with responsibilities related to options and derivatives.
His presentation, posted below, does not offer a lot of commentary, but does have some interesting charts. His contention is that this period of extended low volatility has led investment firms into strategies custom built for this environment and which would be ill-suited to a higher volatility world.
He offers a parallel with the “Portfolio Insurance” schemes of the late-1980s, which were designed to replicate the action of put option-based hedges by selling index futures when prices decreased (this is related to the oft-discussed practice of “delta hedging”). Portfolio Insurance worked well as long as selling volume remained within “normal” parameters. However, when the US market reacted to steep losses in Asia and Europe by abnormal selling, portfolio insurance schemes actually exacerbated losses and sent the S&P 500 down over 20% in one day.
(For those of you interested in 1987’s Black Monday event, I recommend Robert Shiller’s research paper about portfolio managers’ considerations on that day – stored in the Framework Knowledge Base. For those interested in why Asian and European stock markets were down in the first place – I recommend this paper, which is a follow-up to one written by Lawrence Summers, et al, soon after the 1987 crash – this is also stored in the Knowledge Base and contains a surprising conclusion.)
To paraphrase Brosen, the current environment, high corporate debt, bloated central bank balance sheets, and numerous investment strategies tailored for a low volatility world sets current investors up for a “Black Swan” type of shock. As another commentator in England wrote about Brosen’s Grant’s Conference presentation, the present environment could mean that current investors face a bigger threat than investors did in 1987.
As Sheila commented about Brosen’s presentation in our interview, clearly it is dangerous when everyone rushes to one side of the boat (i.e., passive investing, risk parity, volatility targeting, etc.); a little wave stands to capsize the whole thing.