Black Swan Insurance?

Hard to comment without getting into whether or not it is a worthwhile approach. Reading the prospectus carefully should give necessary information (I haven't read it). A 15% loss in bonds is a big loss though. The theoretical problem I see with hedging is something like the 'perpetual motion machine' - how does one find a true 'guaranteed win' situation? Practically, a hedge is covered by a counter-party, and the broader financial world becomes involved in a giant game of musical chairs, with governments (us) bailing out those left without one. Another way of saying the same thing is that the 'risk-reducion' of the hedge is simply passed on to someone else as 'risk- augmentation' in a zero-sum game. The way to win the game is the very traditional method of making the right investment to begin with, and that is a plus-sum game that involves work, not computer modelling.

Dumbstruck

I am assuming that you would be buying insurance on Pimco bond funds.

Paying a very small fraction of your portfolio in order to sleep better, seems like a good idea on the surface. However, one question lingers in my mind: if a catastrophe struck so that very safe bonds, that you are insuring, plunge in value to such extreme extent, from whom exactly will you collect insurance?

Provided that you have very good answer to this question, I would say, go for it.

The basic principles = simple puts and calls on equities. All of this is explained in detail with examples in any good options book.

Hedges cost money.The 'tail risk' is simply a fancy way of saying 'low probability;" it will not limit your upside any more than buying a put will, unless the cost of the put is paid by selling a covered call, then your upside is also limited.

The counter-party or parties will sell the put, and buy the call. If the stock drops, they get it at a lower cost. If it rises sufficiently, they'll benefit from the leverage. Do you see how this is a zero-sum game, jiggling contracts? Hedge funds and later "banks" developed proprietary 'secret' markets for contracts available only to themselves, and various and sundry mutations of the same basic principles.

Think of "tail risk" and "Murphy's Law" in the same abstract sentence.

I find the terminology of options so confusing that I was hoping that a fund could prepackage sort of a blackbox version of it that implements "options for dummies". But I guess you're saying there is no obvious killer strategy that you could expect the fund to implement, and it's better to go into it really understanding the tradeoffs they are messing with. I get dizzy wondering about options expiration dates and who gets the dividend and other digressions... but maybe should seek a better tutorial.

Yes.

Just in case, I'm not making light of your inquiries. Understanding your investments is a basic principle. When one tries to hedge a thin tail without understanding how, look at the fat tail one is exposing oneself to. It's self-defeating. IMO, hedging gets to the point of betting all the numbers on a roulette wheel, to be sure you "can't lose." Try re-reading on puts and calls, it really is not as complicated as algebra. Movement is either up or down.

Understanding at a functional level is important, but it seems fair to insulate yourself from knowing the gory details with packaged products. Furthermore, if widely marketed products appear from reputable companies, it seems fair to introduce yourself to their offering in a naive, top down manner at first, because you are screening rather than making commitment decisions. That was my goal in this topic - naive screening.

There are some option based funds that are easy to understand at a functional level and can serve as useful tools for those not wanting to go thru a learning curve with option details. For instance the inverse funds (which aren't exactly inverse, but close enough for brief emergency uses, and don't have the unlimited loss pitfalls of shorting). I know many hate these, but they have a role.

Another example of packaging is the etf fund(s) for bond ladders. I don't know if they do the job or if it is even possible to do the job, but if I decided I wanted a bond ladder I would most strongly look into it to be done for me. It seems ridiculous for every individual to have to learn and wallow in the ongoing administrivia and expose yourself to lack of diversification, when a product can potentially let a few professionals do the work of a zillion customers.

on 7/28/10 7:45 PM dumbstruck said the following:

If you are confident the $ crisis won't happen but want to hedge us markets, consider using Proshare Inverse EFT's.

on 7/28/10 6:01 PM Igor Chudov said the following:

Igor has brought up a good consideration. $ crisis.

on 7/28/10 6:01 PM Igor Chudov said the following:

Obviously from the son of AIG hoping that the government will bail you out