Alternative Investing
Where the Wild Things Aren't: Using Derivatives and Leverage to Improve Portfolio Performance
May 13, 2010
Topics - Alternative Investing Portfolio Construction Leverage
Institutional Investor
In the current world of modest risk premia, investors face a choice: Limit their investment options and concentrate their risks in traditional equities, or diversify and build more stable portfolios more likely to meet their difficult benefit and spending requirements. Choosing the latter course has a lot of appeal, but it will require — brace yourself — the prudent use of leverage and derivatives.
Investors who cannot or will not use leverage and derivatives are resigned to allow equity market direction drive their portfolio performance. We think a better option is to choose and manage your risks by applying modest leverage to a more diversified portfolio because we believe this approach delivers higher risk-adjusted returns with smaller tail events. Both concentration and modest leverage are risks, and nobody should tell you different. But concentrating in equities simply because it is the more common choice does not make it any less scary.
Leverage and derivatives are just tools. At their best they are useful — in some cases, essential — to reduce risks, by allowing investors to improve asset allocation, make shifts efficiently and cheaply, implement intended bets, close market inefficiencies that would be left open, and transfer risk between parties.
Particularly in a world of narrow risk premiums, growing liabilities and lofty return goals, improvement over tradition is necessary. The way forward is to use everything we have learned from experience and theory to invest wisely the great pools of assets we manage.
This document is not intended to, and does not relate specifically to any investment strategy or product that Belvedere offers. It is being provided merely to provide a framework to assist in the implementation of an investor’s own analysis and an investor’s own view on the topic discussed herein.
This document has been provided to you solely for information purposes and does not constitute an offer or solicitation of an offer or any advice or recommendation to purchase any securities or other financial instruments and may not be construed as such. The factual information set forth herein has been obtained or derived from sources believed by the author and Belvedere Advisors LLC (“Belvedere”) to be reliable but it is not necessarily all-inclusive and is not guaranteed as to its accuracy and is not to be regarded as a representation or warranty, express or implied, as to the information’s accuracy or completeness, nor should the attached information serve as the basis of any investment decision. This document is not to be reproduced or redistributed to any other person. The information set forth herein has been provided to you as secondary information and should not be the primary source for any investment or allocation decision. Past performance is not a guarantee of future performance. Diversification does not eliminate the risk of experiencing investment losses.
This material is not research and should not be treated as research. This paper does not represent valuation judgments with respect to any financial instrument, issuer, security or sector that may be described or referenced herein and does not represent a formal or official view of Belvedere. The views expressed reflect the current views as of the date hereof and neither the author nor Belvedere undertakes to advise you of any changes in the views expressed herein.
The information contained herein is only as current as of the date indicated, and may be superseded by subsequent market events or for other reasons. Charts and graphs provided herein are for illustrative purposes only. The information in this presentation has been developed internally and/or obtained from sources believed to be reliable; however, neither Belvedere nor the author guarantees the accuracy, adequacy or completeness of such information. Nothing contained herein constitutes investment, legal, tax or other advice nor is it to be relied on in making an investment or other decision. There can be no assurance that an investment strategy will be successful. Historic market trends are not reliable indicators of actual future market behavior or future performance of any particular investment which may differ materially, and should not be relied upon as such. Diversification does not eliminate the risk of experiencing investment losses.
The information in this paper may contain projections or other forward-looking statements regarding future events, targets, forecasts or expectations regarding the strategies described herein, and is only current as of the date indicated. There is no assurance that such events or targets will be achieved, and may be significantly different from that shown here. The information in this document, including statements concerning financial market trends, is based on current market conditions, which will fluctuate and may be superseded by subsequent market events or for other reasons.