#82 - Vineer Bhansali - “The Market is Severely Underpricing the Probability of a Sharp, Catastrophic Loss to the Downside"

An episode of the The Meb Faber Show podcast

In Episode 82, we welcome trader, fund manager, and author, Vineer Bhansali.

Per usual, we start with Vineer’s backstory. It involves his physicist-origins, an unexpected move to an assortment of trading desks, and a run-in with the great, Fischer Black.

Meb soon dives in, asking about main strategies Vineer uses with his group, Longtail Alpha. Meb reads a quote from LongTail’s website…

“LongTail Alpha’s sole focus is to find value in the tails of financial asset return distributions. Either in the left tail as a risk mitigation hedge on multi-asset portfolios, in the right tail to add convexity to an investor’s risk exposures, or in both the right and left tails to produce alpha from convexity and volatility opportunities in a hedge fund structure.”

Meb asks Vineer to use this as a jumping off point, explaining his framework, and how he thinks about tail strategies.

Vineer tells us that, at LongTail, they believe the probability distribution of returns for asset classes and multi-asset portfolios is actually not bell-shaped. Rather, there are many imperfections and anomalies in the market. And the tails of the distribution are quite different than the central part. While the central part of the curve tends to have many, smaller moves, the tails tend to be dominated by infrequent, large events. With this in mind, the goal is to implement various options strategies to help you position yourself for these tail vents. Keep in mind, there are left tail and right tail events (and a hedged strategy in the middle). Vineer references them all.

Meb mentions how, right now, most investors are more concerned with the left tail events. So how should an investor think about implementing a tail strategy? And is it even necessary, given Vineer’s statement in a recent Forbes article:

“…people generally feel better when they believe that they have portfolios with built-in insurance, i.e. protection against losses, even though the expectation (or average return) of a portfolio with or without such insurance is the same.”   

Vineer discusses the difference between “volatility” and “permanent loss of capital.” What you want from a left-tail paradigm is a methodology that keeps you in assets, serving your long-term benefit. Generally, you want to be invested in the stock market. Vineer tells us the name of the game is to be able to survive the relatively short-but-harsh pullbacks, and even accumulate more assets during those times. Given this, Vineer has a 4-lever framework he uses to help create a robust left-side portfolio. You won’t want to miss this part of the discussion.

As the conversation unfolds, you’ll hear the guys discuss how, even though there is some concern about a correction now, the markets are still severely undervaluing the price of a sharp downturn. And option premia are incredibly cheap by historical standards.

Meb then asks for more details about actually implementing a left tail strategy.

Vineer’s answer touches on understanding and identifying how much exposure one wants to equity risk and inflation risk. Then, there’s the need to understand one’s risk threshold tolerance – the “attachment point” at which you cry uncle, whether that’s being down 10%, 15%, 25% or more. Given this attachment point, an investor could then go to the options market and buy “insurance” at this level, for a duration of time suitable to the investor. 

This leads Meb to wonder why people think of portfolio insurance differently than life, car, or home insurance. We all pay those insurance premiums without thinking much about it, but there’s so much resistance to paying for portfolio insurance.

Vineer actually wrote a paper on this challenge. He tells us part of the issue is an aggregation, disaggregation problem. The right thing to do would be to lump the cost of insurance into the portfolio and look at the overall portfolio returns. But people fixate on the “lost” cost of insurance when option premiums expire worthless.

Next up, the guys discuss the current volatility environment. Vineer address two questions from Meb: “why is volatility so low?” And “is there a sweet spot on the option scale (how far out of the money) for investors looking to purchase portfolio protection?”

There’s way more in this episode: option selling strategies (instead of buying insurance, you’re the one selling it in order to generate yield)… A great piece from Vineer about selling bonds as a way to hedge your portfolio… How the traditional inverse relationship between market direction and volatility might not be holding up as much (look at Japan recently – surging markets and volatility together)… Vineer’s thoughts on artificial intelligence and “how to beat the machines”… And of course, his most memorable trade.

All this and more in Episode 82.

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68 mins


Wednesday, November 22nd 2017