Hedging to Maximize Returns

Published on
January 28th, 2019
Topic
Risk Management, Volatility, Portfolio Management
Duration
31 minutes
Asset class
Equities

Hedging to Maximize Returns

The Expert View ·
Featuring Hari Krishnan

Published on: January 28th, 2019 • Duration: 31 minutes • Asset Class: Equities • Topic: Risk Management, Volatility, Portfolio Management

Hedge fund manager and author Hari Krishnan, portfolio manager at Doherty Advisors, breaks down his analysis of hedging and profiting from market downturns, concluding with his view of the risks and opportunities in the wake of the December 2018 volatility event. Filmed on January 23, 2019 in New York.

Comments

  • WV
    Walter V.
    20 February 2019 @ 12:43
    Really rich analysis! One thing that never occurred to me in terms of hedging is the 'repricing' aspect of OTM options that Hari brought to light. His book is also very good, I was presented to it here and loving every chapter. Can't wait for the second one.
  • AV
    Adam V.
    10 February 2019 @ 01:44
    Hari, in your analysis, are you equating credit availability due to QE to Dollar liquidity? Do you consider them one and the same or two different dynamics on the market?
  • RP
    Ryan P.
    2 February 2019 @ 14:47
    Good point in levered etfs. Someone should look at total returns for any extended periods of time on literally any etf. It just decays. They literally light money on fire holding them over time. They are a trading product. AI he makes another good point between machines and humans. These machines should complement processes not take over. Humans need to navigate the ship. Machines are the rowers. The fact that the last 7-8 years we have had relatively flat volatility or always reverted to the mean, (low). What will the machines do in the face of uncertainty and unwinding of things that “have always been”? Good piece. Good luck all.
  • RM
    Ryan M.
    31 January 2019 @ 14:12
    Wow! I quite enjoyed that. Bring him back again soon please.
  • JF
    Joseph F.
    30 January 2019 @ 03:23
    Excellent. Thanks.
  • JC
    John C.
    29 January 2019 @ 19:57
    Great video. Very well presented and informative. Need to get him back on again thx.
  • JH
    Jesse H.
    29 January 2019 @ 17:42
    Excellent - thank you, Hari, for this thoughtful and thought-provoking presentation.
  • PC
    Peter C.
    29 January 2019 @ 16:01
    Great piece. added his book to my reading list.
  • TT
    Trenton T.
    29 January 2019 @ 15:52
    Great piece; I will buy Hari's book to obtain depth before posing questions. Nice to see all the contributor engagement! Could RV please arrange Hari to provide comity training to the US Congress?
    • HK
      Hari K. | Contributor
      29 January 2019 @ 16:37
      Thanks Trenton, I'll look to shave my head and offer meditation lessons as a career Option B :-)
    • MK
      Mike K.
      31 January 2019 @ 06:07
      Audio book please @Hari K.
  • AP
    Antonio P.
    29 January 2019 @ 15:10
    Excellent video!
  • MC
    Matthew C.
    29 January 2019 @ 14:27
    Very good interview, a properly and consistently hedged book will always outperform over the long term. The scenario that still keeps me on my toes is the non correlated "flash crash type" liquidity gaps in single instruments - swiss franc, pound, yen a couple of weeks ago have all see isolated moves of 10-40%, and thats if you are lucky enough to get filled at those levels. Options only work if you have the specific contract. Even large experienced funds have been wiped out overnight on these events. Would love to hear your view on how you handle this Hari.
    • HK
      Hari K. | Contributor
      29 January 2019 @ 16:35
      Another fine question. Sorry that my response rate is slowing, but I have a few things on my plate. In the Second Leg Down book, I tried to argue that a wide variety of hedges would work during a systemic risk event. I basically showed that it was very unlikely for any 2 of the currency VIX, Treasury VIX and equity VIX to be well above normal without the other one at a "normal" level. So that gets you some of the way (if you buy this argument, you can hedge in the asset class where vol is cheapest). However, for things like the CHFEUR cross, this approach isn't going to work. I'm planning to apply research on fire sales to identify overowned and dangerous markets in the next book. It won't solve the "depegging" or localized Black Swan problem. The only advice for pegged currencies is: don't scale your position as 1/(realized volatility), as the realized vol vastly underestimates risk.
    • HK
      Hari K. | Contributor
      29 January 2019 @ 16:39
      Sorry, a slight mis-statement in my post below. It's unlikely for 2 vol indicators to be very high and the other at an average level or below.
  • CM
    C M.
    29 January 2019 @ 03:33
    Hari was great. Deep thinker on the market. Highly enjoyed this video. Looking at the market pragmatically.
  • KL
    Ken L.
    29 January 2019 @ 03:28
    Took some difficult concepts and talked in a very simple kind of way. Thank you Hari.
  • F
    Floyd .
    29 January 2019 @ 01:22
    Great presentation. However,could have been a bit more clear in describing what Exchange Traded Securities pose risk. Generally speaking I heard ,leveraged products that invest in areas that mean revert,poorly structured products and products that invest in leveraged loans. What about other large products that haven't seen a real bear market yet..like the SPY etc.. And never got to the"angel" comments.
    • HK
      Hari K. | Contributor
      29 January 2019 @ 01:56
      Good point ... Other danger areas are high yield ETFs, where there's a liquidity mismatch between the ETF and underlying cash bonds and bond ETFs in general. Redemptions will force selling of bonds that hardly trade.
    • CN
      Charles N.
      29 January 2019 @ 18:58
      ☝️☝️☝️
  • DS
    David S.
    28 January 2019 @ 22:48
    Excellent presentation. I am too old to put in the effort to understand and properly hedge. My hedge is being way overweight in cash equivalents for capital preservation. For portfolio mostly in stocks and bonds, hedging risk is now essential. I know that you have helped them. If they did not listen, they will learn the hard way. I hope to see you back soon. Thank you for answering commenters questions. Good use of the subjunctive tense. DLS
    • HK
      Hari K. | Contributor
      29 January 2019 @ 02:08
      Thank you fine sir
  • SS
    Steve S.
    28 January 2019 @ 22:29
    @ Hari. What about Gold as a hedge during volatility?
    • HK
      Hari K. | Contributor
      29 January 2019 @ 01:59
      Gold is a hybrid inflation/Armageddon hedge play. If you believe that either a. the market is going to h*** in a handbasket or b. money will be pumped into the system causing currency devaluation with nothing in between, it's a great hedge. Tough to apply in intermediate situations. Thanks!
  • NC
    N C.
    28 January 2019 @ 19:54
    Great interview. I learned something new. Strangely, I kept thinking I was listening to Malcolm Gladwell...
  • TJ
    Terry J.
    28 January 2019 @ 16:09
    I almost did not watch this, simply due to time constraints and not having heard of Hari before. So glad I did. Thanks Hari for some fascinating and thought provoking insights. I learnt so much. Top drawer again RV!
    • DR
      David R.
      28 January 2019 @ 19:46
      Same here, so thanks to your comment I will try to watch (or read the transcript; more fast & focused but lacking if charts are missing).
  • DB
    David B.
    28 January 2019 @ 15:18
    Hari, You argue that the Fed's $4+ Trillion balance sheet expansion INCREASED the amount of debt in the world thereby making equities smaller on a relative basis...which makes equities more scarce and therefore bid higher. (I think I got that right.) How does the Fed's BUYING of debt INCREASE the amount of debt in the world? I'm not saying you are wrong...I'm just looking for the missing link in my mind! Thanks in advance!
    • HK
      Hari K. | Contributor
      28 January 2019 @ 15:27
      Increase in Fed liabilities ==> increase in deposits somewhere in the system ==> more bonds + cash ==> supply of equities proportionately lower than (bonds + cash). Add corporate buybacks & you get a scarcity of equities, whatever the valuations might suggest … http://www.philosophicaleconomics.com/2013/12/the-single-greatest-predictor-of-future-stock-market-returns/ is a great reference on this idea, not written by me. All the best, Hari
    • DB
      David B.
      28 January 2019 @ 15:41
      Thanks again, Hari. Terrific presentation! I was thinking along the lines of your explanation but assumed that assets & liabilities offset each other. I will look further. I expect what I am missing is the velocity of additional deposits in the system. Warmest regards.
    • JK
      James K.
      28 January 2019 @ 16:19
      I’ll second that question.
    • HK
      Hari K. | Contributor
      28 January 2019 @ 18:22
      great follow up questions, thanks! the idea is roughly this: suppose a bank (any bank, not just the Fed) approves a loan. let's say a house is bought, 100% on loan. the bank then has a mortgage on its books (asset to the bank) and deposits the sale amount in the homebuilder's account (liability to the bank). assets and liabilities cancel out from the bank's perspective. however, deposits that can be put to use in buying something else (stocks, bonds or real investment) have increased. the loan increases the total size of the bank's balance sheet and deposits increase money to chase assets in the system, but as you say assets and liabilities offset. hope this helps! the danger zone is when credit is very large and starts to contract.
    • VK
      Viresh K.
      28 January 2019 @ 22:27
      I don’t know if I buy that argument. QE was the buying of bonds via the creation of Fed money. Fed gets bonds Commercial bank gets reserves which they hold at Fed (usually) Ex holder of bonds gets deposits If anything, the argument could be made that QE reduced the supply of bonds, but even this would probably be false as the size was never large enough, and you can see this when you compare US 10 year YoY vs ISM or something similar. I don’t see how it changes the composition of public assets to make equities more scarce at all.
    • HK
      Hari K. | Contributor
      29 January 2019 @ 02:01
      Viresh, I can see your point ... I have framed the portfolio selection as a choice between bonds OR cash (0 duration bond) and stocks, though. I'm lumping cash together with bonds. The philosophical economics article spells this out.
    • VK
      Viresh K.
      29 January 2019 @ 08:24
      Hey Hari, thank you for responding!
  • VP
    Vincent P.
    28 January 2019 @ 14:39
    Good presentation. That diagonal calendar, to calendar, then to vertical Put structure to "still" work out well by June!
  • FG
    Flavio G.
    28 January 2019 @ 12:30
    Question for Hari: You mentioned that humans have an edge over models because humans draw from previous experiences. Don't you think it is also a matter of incorrect modelling? For example (non-methematician here): If your model incorporates Bayes, wouldn't Bayesian updating account for previous knowledge if the model is correctly fed with a variety of cycles?
    • HK
      Hari K. | Contributor
      28 January 2019 @ 14:39
      Hi Flavio, thanks again for your interest! I aim to please with these things. Re: humans vs models debate. I guess I wasn't very clear on this point. Models (good ones, in any case) beat humans in terms of consistency, aggregating huge amounts of data and testing for hidden structure. However, any inference engine has to change its rules more slowly than the data flows in. That's required for model stability. So if you've been in a long bull market, most models will find a way to get long equities and the longer the bull cycle, the more convinced a model will become that long equities is the right thing to do. You can try to get around this issue by de-trending data etc. but I think my argument is broadly correct. Is it any surprise that momentum is everywhere in the age of automation? Now the danger is that if there's a sudden regime shift (think "Flash Crash" or deleveraging), your model is going to be levered, long and wrong. Humans are generally quite good at identifying that something has structurally changed and more importantly, options allow you to take contrarian positions at low cost when expressing "out of favor" views. My point is that you can use programs to latch onto the way markets are currently moving, but are well served to add convex structures (read options) to account for regime shifts. Grazie!
  • FG
    Flavio G.
    28 January 2019 @ 10:48
    This guy is extremely smart and well informed (Bonus: great subtle sense of humour). This is definitely a bump-up in the quality of interviewees at RV. Would love to watch more of Hari during 2019.
    • MP
      Matthew P.
      28 January 2019 @ 11:40
      Disagree, 30minutes spent of pontificating common sense. Still appreciate the content.
    • HK
      Hari K. | Contributor
      28 January 2019 @ 14:42
      To Matthew P.: thanks for your feedback. I am always happy to answer specific questions about the macro landscape & trade construction on demand.
    • LB
      Lerey B.
      28 January 2019 @ 21:09
      I agree. Great interview. And to me much of this is not common sense. Perhaps some videos could be labeled beginner/ intermediate/ advanced or something to help people understand the complexity of the content. I would put this intermediate or between beginning & intermediate personally which is perfect for me.
    • MC
      Matt C.
      29 January 2019 @ 07:00
      I thought this was one of the best interviews on RV. More Hari, less Mark Cuban.
    • DS
      David S.
      31 January 2019 @ 19:13
      A well-presented argument often sounds like common sense after it is made. The actual hedging is complex and not common sense, at least to me. DLS

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