Recently, I have noted several instances where conventional wisdom is challenged. It is worth repeating these. The reader is welcomed to add further examples, comments or criticisms.
Inverse Glide Paths
Common wisdom for retirement planning dictates that the asset mix in a retirement portfolio varies such that the riskiness (or volatility, or potential capital loss – I won’t discuss the specific risk measure or investment blend here) of the portfolio decreases as time to retirement (and drawdown) approaches. This glide-path approach is widely followed by fund managers and financial advisers. Recently, Rob Arnott (of RAFI fame) has published results of a study which supports the view that Inverse glide-paths work better.
The study concludes that “increasing exposure to equities later in life… produces better investment outcomes.” The volatility of the outcomes is also lower.
Something to think about.
US Treasury Bonds and Out of the Money Put Options hold Similar Risks
Why Risk-Free Assets are Risky, is an interesting article (via Artemis Capital), posted on the ZeroHedge Blog. It provides an analysis of selling out of the money options, compared to investing in so called “risk free” US Treasury bonds. Each of these assets generates a regular cash inflow – a coupon for the bonds, and premium from the sold options. Capital allocated to cover the potential exercise of the options is likened to the principal of the bonds. In a crisis situation, the losses an investor would suffer are similar.
An interesting investment strategy, and potential source of diversification….
Investing in Bad Companies
This little gem, I heard about a long time ago. Do not take this as investment advice, and seek out bad companies. It is purely anecdotal.
Imagine two companies producing (the same) widgets. Currently, widgets sell for $10 apiece.
|
|
Company A |
Company B |
| Production Cost/Widget |
$2.00 |
$8.00 |
| Selling Price |
$10.00 |
$10.00 |
| Margin/Widget |
$8.00 |
$2.00 |
On first inspection, Company A looks to be the better investment. With a margin of $8 per widget, it is four times as profitable as Company B. This is most likely factored in to the current share price.
Assume, that we expect the price of widgets to double to $20.00. Assume also that the cost of production does not change. The companies now look like this:
|
Company A |
Company B |
|
| Production Cost/Widget |
$2.00 |
$8.00 |
| Selling Price |
$20.00 |
$20.00 |
| Margin/Widget |
$18.00 |
$12.00 |
In an absolute sense, Company A is still the more profitable. Relatively, however, Company A has increased profitability (per widget) by 125%, while Company B has increased profitability by a massive 500%. If the scale of these increases is reflected in movement of the share price, then Company B would have been the more attractive investment under this scenario.
Further, Company B is also more attractive as a takeover or restructure target. If cost savings, or synergies can be generated via a corporate event, or restructure, then these would translate into the share price of Company B. Caveat: Under pressure, the longevity of Company B would be under threat. It is also a much more volatile and risky investment.
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