I meant to write this post for Tuesday but we had a structure fire Monday afternoon that kept me busy until around midnight (most posts are written the night before).
Bloomberg had a quick write up giving us the latest on once legendary mutual fund manager Bill Miller. Although he no longer manages the Legg Mason Value Trust he does still manage the Legg Mason Capital Management Opportunity Trust (LMOPX) and the fund is doing very well with a 29% YTD return through October 11.
The article notes the extent to which the fund has had this move by concentrating in banks, home builders and mortgage REITs. The Morningstar page for the fund says the risk is high and most of the related stats are not good either.
So the market is having a good year and the fund is doing very well. Any guesses what the fund will do the next time the market goes down a lot?
There are funds and managers that are very much live by the sword which is fine up to a point. What I mean by that is that many fund holders did not realize that certain managers were living by the sword, that is taking very big risks.
It is very easy to look at a stock or a fund and know whether it is more likely to go up more than the market on the way up and down more than the market on the way down. Caterpillar (CAT) is a great example of this and one I have mentioned many times before. And so apparently are funds managed by Bill Miller.
Most of the time a portfolio is a mix of holdings with various volatility profiles. Typically when it looks like the market might be on the road to down a lot we will look to reduce the portfolio's volatility by selling names that tend to be very volatile--relative to the portfolio.
Understanding what each holding is likely to do (no guarantees) in the face of a large decline should go along way to managing the amount of volatility you are exposed to.
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6 comments:
Time to pull out the old behavioral finance book and take a look (self-examine) at various cognitive biases.
This post has a haughty tone to it. It is a real turn off from your usual musings.
It's modestly interesting that CAT has not had a particularly good last year in spite of its beta. Contrast to NVO, a nondiversified and theoretically low volatility health care company, which is up 75% over the same time frame. I find myself wondering which equity I would want to hold in the event of the market heading south: a low volatility company which has just finished a big runup, or a high volatility company that has underperformed recently.
We have owned NVO for quite a while now and I think of it as being a volatile stock.
When you correlate for volatility, do you choose the S&P 500 for your correlation, or a sector appropriate Index or etf?
I assume you are still interested in maintaining a diversified portfolio with some holdings in each sector, possibly underweight depending on your expectations for the cycle. That's the reason for the above question. Would the substitution of an etf at a reduced portfolio % be the answer for a high volatility stock in an expected unhealthy market? Or will you always default to cash?
Thanks,
Sam
Sam,
Switching from individual stocks to a sector ETF can be a way to reduce volatility (depending on the stocks and depending on the ETF) and we have done that sort of trade in the past. We have also raised cash depending on the circumstance.
Maintaining a diversified portolio is always a priority so we look to reduce volatility sector by sector up to a point; we probably won't reduce the volatility by selling a utility stock for top down reasons like we might from selling an industrial stock.
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