This column usually tackles practical aspects of investing, but I thought I would try a more philosophical discussion on investing...
This column usually tackles practical aspects of investing, but I thought I would try a more philosophical discussion on investing...
This column usually tackles practical aspects of investing, but I thought I would try a more philosophical discussion on investing...
This column usually tackles practical aspects of investing, but I thought I would try a more philosophical discussion on investing, which was prompted by a recent discussion with a hedge fund manager on protecting a portfolio from large (but relatively rare) crashes that can set back retirement goals by a decade, and in some cases even permanently.
Rather than another analysis on current expensive valuations of many equity markets around the world, some readers may find this article a more useful introspection on their personal investment philosophy.
This discussion started on whether it is worth paying a premium to hedge large downside risk, similar to insurance. Conventional wisdom being that it’s not worth paying such a premium as it reduces total returns over the long term compared to an un-hedged all-equity portfolio. And it can lead to significant blunders, such as when the new Chief Investment Officer of the California Public Employees’ Retirement System (CALPERS) after paying for the hedging costs for a number of years, decided to take it off at the beginning of 2020, just before the COVID bear market happened, when it would have delivered the targeted payout to offset the equity losses.
But the discussion took an unusual philosophical turn around the concept of eternal recurrence, which caused me to take a much deeper look at my own investment strategy, and not just as it relates to downside hedges.
The philosopher Nietzsche explained this concept as follows:
Imagine that a supernatural being came to you and said that you had to re-live your life exactly as you have lived it now, with ‘every pain and every joy’, all in the same succession and sequence, over and over again for eternity.
Would you curse such a situation, or would you embrace it? Nietzsche’s personal fundamental doctrine was that to become a great human being you would embrace such an event: you would live your life in such a way as to want nothing to be different, neither in the past nor in the future, for all eternity. And you would not just accept this, but embrace it.
Let’s apply this to our personal investment journey. If we were to relive all the investment decisions and experiences we’ve had, good and bad, over and over again for eternity, would we do things differently? Our answer would not be solely dependent on the outcome. Invest long enough, and you’ll have your fair share of both good and bad results. Upon deeper introspection, would you willingly accept the emotional anguish you feel every time your portfolio loses money in a bear market, over and over for all eternity? Or every time that a stock you own falls by half in a week due to one of any unexpected events (mismanagement by the CEO, fraud, COVID, Archegos, or any one of the other millions of ways that things can go wrong)?
Just one big loss impacts your portfolio’s compounded return in a painfully disproportionate and permanent way. And on average, we experience such events once a decade. Would you want to spare yourself this recurring emotional pain for all your future investment lives?
Most investors today have experienced ‘only’ a halving of their equity portfolios during severe bear markets like the Asian financial crisis and 2008. Any investor who went in leveraged with derivative exposure fared much worse. Archegos lost all of its assets just two days earlier this year. But we know from history that even un-leveraged equity portfolios can lose 80% of their value in a bad year.
Taking all of this into account, in my own introspection, I’ve concluded that these big downside risks should always be protected against, especially if it can be done in a cost-effective manner that doesn’t end up being a significant detraction to total returns over the long term. Of course, how to actually do this is a complicated task that takes up much of the time of many of the greatest investors.
You may come to a different conclusion, but it is worth having a deep think about this.
Within this framework, there’s only one question to ask yourself when making all your future investment decisions. If I had to live with this decision over and over (taking into account both the potential positive outcome as well as the negative outcomes), would I embrace all outcomes? If your answer is no, you may need to rethink your choice. Answering this question honestly will align with your personal investment philosophy and your investment portfolio.
By LEONARDO DRAGO
Co-founder of AL Wealth Partners, an independent Singapore-based company providing investment and fund management services to endowments and family offices, and wealth-advisory services to accredited individual investors.