Summary
- In this commentary, we discuss what we mean by the phrase, “no pain, no premium.”
- We re-frame the discussion of portfolio construction from one about returns to one about risk and argue that without risk, there should be no expectation of return.
- With a risk-based framework, we argue that investors inherently act as insurance companies, earning a premium for bearing risk. This risk often manifests as significant negative skew and kurtosis in the distribution of asset returns.
- We introduce the philosophical limits of diversification, arguing that we should not be able to eliminate risk from the portfolio without eliminating return as well.
- Therefore, we should seek to eliminate uncompensated risks while diversifying across compensated ones.
- We explore the three axes of diversification – what, how, and when – and demonstrate how thinking in a correlation-driven, payoff-driven, and opportunity-driven framework may help investors find better diversification.
Read the full article right here: https://blog.thinknewfound.com/2019/02/no-pain-no-premium/amp/
