If you were involved in markets during the financial crisis, you probably came across the term Minsky Moment. Attributed to Economist Hyman Minsky, the simple version is that a lack of volatility results in complacency on the part of market participants which is when crises happen. It's a little more involved than that where cash flow exceeds the amount needed to service debt causing that excess to speculatively chase prices higher before it ends in crisis. There is a relationship to Black Swans, the end result of the Minsky Cycle as it is sometimes known could be a Black Swan like the Financial Crisis.
The simpler variation of a lack of volatility leading to the bad kind of volatility is the purpose of this post. A couple of times recently, I've quoted Tarek Abou Zeid who made a joke about catastrophe bonds not having any risk or volatility until they do have risk and volatility. That joke overlaps with Minsky.
The portfolio labeled as Minsky, is comprised of three funds. It tracked 60/40 until 60/40 broke in 2022, it has had much lower volatility and far better portfolio stats than 60/40. Looking at the track record, who wouldn't want that smooth of a ride combined with a robust result in 2022 when it was up 2%?
The Minsky portfolio allocates 70% to a fund that combines equities and managed futures, 20% to a catastrophe bond fund and 10% to fund that sells volatility that is pretty far out of the money.
Cat bonds and selling volatility are two great examples of no volatility or risk until there is volatility and risk. The right (or wrong) combination of wind events and wildfires could cause real problems for cat bonds. Some sort of Volmageddon redux (in the last couple days people have noted unusual action in VVIX, the volatility of VIX as concerning) could hurt the volatility fund. It had some sensitivity to the big drop on August 5th and a little less so to Sept 3rd. We've noted a couple of times in the last couple of years where managed futures got whipsawed pretty hard, once in a sharp reversal in bonds about a year and a half ago and then last month with the yen.
Now imagine a slightly bigger event happens to each of the three of them at the same time. You might be down 25% in a down 5% world or maybe the world goes down 25% too but snaps right back like in the Pandemic Crash of 2020 but the Minsky Portfolio we created for this post does not.
How likely is that to happen? Very unlikely, but that is not the point. We do a lot here to focus on managing volatility and the tools discussed today and other tools we talk about, for my money absolutely work but they are not riskless. Equities continue to work and we are frequently reminded of how unriskless they are. Eventually, something with no risk circles back around to become very risky ala Minsky, there is risk waiting in these tools. There may never be a consequence for that risk but it is crucial for good portfolio management to understand the risks of the core (probably equities) as well as the defensive components to avoid getting Minskyied.
Closing out with a quick follow up on the Tradr 2x SPY ETFs we mentioned the other day. SPYB resets weekly and SPYM resets monthly. They don't really have any interest yet. You can see today they were down about four times what the reference SPY ETF was down but that was the market price. According to the Tradr website for SPYB the NAV dropped from $23.86 yesterday to close at $23.73 today. So the fund is trading at a discount but the percentage drop today in NAV of 0.54% is reasonably close. I did not get the info for SPYM. It is too early to know what to make of these but it is worth following.
The information, analysis and opinions expressed herein reflect our judgment and opinions as of the date of writing and are subject to change at any time without notice. They are not intended to constitute legal, tax, securities or investment advice or a recommended course of action in any given situation.
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