Also in this edition of the GMO Quarterly Letter
By analyzing the vulnerability of portfolios both against eternal risks and any particularly relevant risks, we have gained knowledge we can use to help us decide whether there are any risks it makes sense to hedge against today, as well as to help us alter the underlying asset mix to improve the portfolio’s robustness. Occasionally, markets will be sufficiently mispriced that we can get insurance for free, or actually be paid for it. Such times are to be treasured, but they are the exception rather than the rule. Most of the time, hedging and asset shifting decisions are not easy and involve trade-offs that have real costs to them, either in terms of lower expected returns or worse returns in a scenario that we may well care a good deal about. Our goal is to improve expected outcomes in the events we fear without paying too large a price in lower expected returns or increased risks against other scenarios. This is not always possible, and when it isn’t, we’ll suffer some insomnia. Losing sleep isn’t fun, but overpaying for sleep aids will wind up hurting in the long run.
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