Gap Risks, Equity Hedging, Warren Buffett and Elon Musk
Top 5 of the Week of August 15
This week’s Top 5 begins with Joe Becker, of Milliman Insights, who shares how investors should learn to recognize the consequences and frequency of gap risk events to better protect themselves from them. Samuel Lee, a blogger for the Mutual Fund Observer, teaches us when we should be scared of the stock market. And Dr. Jack Vogel, a writer for Alpha Architect questions whether it is possible for the average investor to tame the momentum investing roller coaster.
George R. Evans from Oppenheimer Funds divulges why they continue not to hedge their equity portfolio after 20 years. And Vintage Value Investing author John draws some surprising similarities between risk-loving entrepreneur Elon Musk and value investing guru Warren Buffett…
Gap Risks: One-Out-Of-A-Thousand Events
- Gap risks occur following black swan events (such as Brexit in June this year), they’re those significant drops in share prices overnight—uncommon, but their consequences can be dire
- Before Brexit, in the last 66 years, only two other events have affected the All S&P Index for market losses over 10%; the 1987 and 2008 stock market crashes
- For protective measures against such events consider reducing your exposure to riskier assets by holding more cash and bonds, buying put options, hedging your equities, and portfolio diversification
When Value Investors Should Fear the Stock Market
- For the long-term investor, the periods during which you should step back from the stock market are few and far between
- Retreat only when stock prices become implausibly high, during severe—almost apocalyptic—recessions, or when large numbers of people are fleeing the country (a sure sign of economic impairment)
- The major factor on the horizon to watch at the moment is if interest rates start to rise as happened in the 70s and 80s: which may indicate severely weak returns in the future
Can Stop-Loss Rules Tame the Momentum Investing Rollercoaster?
- According to Jegadeesh and Titman (1993) in the paper Intermediate-Term Price Momentum, it is possible to use simple stop-loss rules to halt or minimize crashes
- But it would require daily stock position analysis to work and would be an unfeasible process for an average investor to perform
- On paper, the theory seems sound but doesn’t account for all the complications in practical execution
Equity Hedging Uncovered
- Attempting to hedge equity investments is the equivalent of trying to accurately hit a moving target while blindfolded
- As successful equity hedging is all about accurate timing, it does not necessarily mean increased returns
- In theory, it should allow you to make returns risk-free but as a process, it’s costly and doesn’t work well enough in practice to warrant the expense—though there are companies and people out there who do it successfully
Do you disagree? Have you been successful at hedging equities? Share your comments in the section below
Elon Musk and Warren Buffett: Play Spot the Difference Between the Two
- One is renowned for his Silicon Valley start-up companies out there disrupting long-standing industries and the other for being one of the most successful investors in the world
- They both drive companies that are making inroads into carbon-free electricity, both make returns with creative fund schemes, and both are decisive leaders in their respective fields
- Lastly, their personalities and brands are both inherently linked with the companies they run
Top 5 of the Week is a summarized collection of financial investment articles that we like and think you might like too. Having written thousands of pages of equity strategy and company research between us, we understand the allure of the ever-changing world of finance. Investing is an art form – and like everything, something you can work on and improve at. There are some excellent writers out there on the finance web, some offer a running commentary on today’s market, some are doing research, some have tips on how to Become a Better Investor, and some just lift the cloud of fog behind a lot of financial jargon. Each week we will keep you up to date with the top 5 articles worthy of your attention.
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