White paper — Hope for the Best and Prepare for the Worst
Swan Research — Innovative Thought Leadership
Although we are many years removed from the depths of the financial crisis of 2007-08, investors remain justifiably scarred by the calamity. However, the passage of time also offers the opportunity to assess what went wrong and how to avoid repeating past mistakes.
Many investors thought they were well positioned by following the rules widely preached throughout the financial industry prior to the crisis. In an effort to minimize risks, they invested in portfolios diversified across asset classes and styles. However, when markets started to unravel in 2008, the scope and severity of the losses were much worse than what most people anticipated under their worst-case scenario projections.
The causes and blame for the financial crisis and subsequent Great Recession have been hotly debated and lie beyond the realm of this paper. The intent of this paper is to address the misconceptions and missteps that intelligent, rational investors made prior to the crisis and that resulted in significant losses of wealth. Three misconceptions stand out:
- Extreme market corrections, or “black swans”, are rare and happen within a predictable level of (in)frequency
- A well-diversified portfolio is the best way to minimize risk
- Risk is defined as volatility
This paper closes with a description of the Swan Defined Risk Strategy, which was designed to address all three of these fatal flaws.
The Swan Defined Risk Strategy was designed to address the three fatal flaws in mainstream portfolio thinking. Recognizing that: 1)traumatic events do occur with alarming frequency; 2) a truly different type of return is needed to diversify risk; and 3) risk should not be solely defined by volatility, the Swan Defined Risk Strategy was built to provide capital preservation during periods of market turmoil. In addition, the Swan’s Defined Risk Strategy was designed to capture a good portion of up markets as well.
There is also an executive summary version of this paper available as well.