BGR, part two. One of the things I hate about MPT is its absolutely idiotic concept of risk. This is based upon two factors. First is comparing to the market, whatever you define the market to be. That is nonsensical. Where is it carved in stone that the market embodies an acceptable level of risk? Who gets to spend relative dollars? This is the crux of the argument I had with Abby Joseph Cohen in 1979. If the market was down 30%, she would claim that a fund that lost 20% did a "good job." I would claim that the portfolio manager who lost 20% should be hanged at dawn. And the Indexer who lost 30% should be tarred and feathered and then hanged at dawn.
Next, for some goofus reason, MPT skinks seem to relate risk to volatility. Nonsense. Volatility on the losing side is definitely risk. But volatility on the winning side is opportunity. To throw both types of volatility into the hopper to determine a measure of risk is insane. And then to use "the market" as the 1.0 factor compounds the insanity.
O.K., nobody brainwashed by the statistically minded Finance fraternity is going to buy logical arguments. So, let's turn to the practical questions you asked. How do I measure or control risk in my portfolios?
I have 3 portfolios. The 90/10 has an absolute, not a relative risk factor. I can never lose more than 10%, and, for practical purposes, can probably never lose more than 6% or so. Yet, the upside potential is greater than the market's. Of course, that is only so because I use a contrarian approach and a homerun mentality while employing a risk-limiting money management technique.
In the Maximum Income Portfolio, I endeavor to take negative risk, though this is not always possible. I employ techniques that have defined and sometimes absoloute negative capital risks, such as credit spreads, convertible arbitrage, Butterfly Spreads and Leap arbitrage. I also try to diversify among bullish, bearish, and market neutral positions. And, of course, I derive the income from equity, fixed income and futures markets, which further diversifies the effort. Paired trades, such as my multi-year Long Intel/Short Motorola position, where the short side does not have defined risks, usually make up less than 10% of the total portfolio. And I find myself doing more of these with Leaps for less risk. Even more so than in the 90/10, the contrarian techniques reduce risk and increase returns. In my personal IRA income portfolio, I have to take a few more risks, as many of the techniques I use in Maximum Income cannot be used in an IRA. So, I cannot do credit spreads, but I can do spread conversions. Not as good, but still, pretty good. And many are done with negative absolute risk.
In cap app, I take risk depending upon what I determine to be the fair value of both the market and the stocks I like. But the risks are more determined by the allocation to cap app than by internal risk reduction or payoff enhancement. Some folks ask why I even have cap app, and the answer is that there are stocks and futures I want to own that do not have options, so I can't use them in 90/10. And, there are stocks and futures that do have options, but the premiums are too high for me, so I buy the undelyings instead. Right now, the cap app is 10% of my total portfolio.
MB |
