Tuesday, May 20, 2008

Three Little Pigs - CFA version (Updated)

Once upon time there were three little pigs. One day, they gathered around their mother (who was a CFA as it happened) and listened to her say: "Little pigs, it's now time you all went out into the world and built yourselves portfolios of your own. "Luck be with you. But...you must be careful to watch out for the Big Bad Black Swan."

So the three little Pigs set out on their merry way to build themselves portfolios that would make their mother proud, withstand the prevailing shocks of the day, and test of time, and produce fine cocktail party conversation when they socialized with the other Pigs.

The first little pig built himself a portfolio of AAA rated US RMBS securities backed by less-than-high quality mortgages which he was told (by the rating agency and the bond salesman) had excellent modeled risk characteristics for the additional yield, Chinese shares (for their future growth potential), and a basket of US Municipal and Financial Guaranty insurance companies whose underwriting record the first little pig assessed with hindsight "was near-perfect" rarely having to pay a claim (e.g. ABK, MBI, AGI. MTG, and PMI). The First little pig enjoyed his new portfolio, and felt safe, as it did wonderfully - impressing friends and family alike and attracting the attention of London-based fund of funds, and hedge fund seeders, and all manner of private hot-money investors, until one day, the Big Black Swan came swaggering down the road, and asked to have a look at his positions. The Swan (whose "big" and "bad" reputation was really undeserved for he was really just a bit of a skeptic) said to the pig: "Little pig, little pig...just wondering but, ummm, do you think that portfolio of yours will withstand a bit of huffing and puffing?" Oh indeed it's a very conservative portfolio - with uncorrelated value and growth elements, backed up by the finest of American residential collateral!". "It won't fall...not even if all the shares in my China tea-basket falter!" said the little pig. The Swan shrugged his wings (for he'd heard this before) and went on his way. A while later, he ran into the pig, who was looking decidedly worse for wear, threadbare, and forlorn. "What happened to you?" said the Swan. "Well , my RMBSs got downgraded and now there's no market for them (25 offered - no bid), my China shares halved and the dollar's STRENGTHENED vs. RMB, and my safe insurance basket been 'Acked to pieces!" "Shit happens" said the Swan...

The second pig, after leaving home, was suspicious of assuming too much market risk, and so took a different approach and built himself a portfolio of blue-chip hedge funds with pedigree managed by ex-Harvard Superstar Jeff Larson, ex-Morgan Stanley superstar, Vikram Pandit; ex-Goldman Partner Ron Beller; and Bear Stearns bravado Ralph Cioffi; as well as a wodge to UBS superhero, Jon Wood, (on top of a "safe" multi-strat called Amaranth managed by Nick Maounis (because he was a conservative pig at heart, and liked the diversification that a multi-strategy arbitrage-oriented fund afford him).

The second little pig, feeling impervious to risk, was admiring his stable of managers, and feeling very wealthy and important when one day, while lunching at Nicole Farhi's, the Big Black Swan came swaggering over to his table, and asked to have a look at his positions. The Swan (who despised being confused with a goose) said to the pig: "Little pig, little pig...I was just wondering but, ummm, do you think that portfolio of yours will withstand a bit of huffing, puffing, volatility spikes and global financial deleveraging??" Oh yes, it's a very conservative portfolio - with uncorrelated alpha sources and the best brains, risk-control, and financial systems and oversight that money can assemble." "It won't fall down...not even if all the China shares in my managers' long momentum portfolios puke!" said the little pig confidently. The Swan shrugged his wings (for he'd heard this before) and went on his way. Some time later, he ran into the second pig, who was almost unrecognizable, no longer dressed in a smart Saville Row tailored clothes, but now-donning the simplest of Indian white cotton robes. "What happened to you?" said the Swan. "Well", said the pig, "my multi-strat manager combusted up on natty gas, deleveraging and hubris bankrupted several of my others, and Jon Wood's SRM choked on a large piece of North Rock and an even larger piece of Countrywide, so I've gone off to an Ashram like David Weill before me, to find some spiritual solace". "Well, shit does happen" honked the Swan somewhat sympathetically...

The third little pig was cleverer than her siblings, and sought out the the strongest materials with which to build her portfolio. She (quite literally) stuffed it with steel producers, commodity ETFs and other physcial things that hurt when you dropped them on your foot, global mining and resource companies (especially Iron Ore and Metallurgical Coal). And she bought potash mines from the Dead Sea to Saskkatchewan, a block of apartments across from the Kremlin, and deep-water platforms and GOM fields wherever she could find them. Concerned that she might be top-heavy on "value", she leveraged and bought a bevy Emerging market shares in Brazil and Russia, and added a short USD vs. long AUD position on top of the highest yielding carry basket she could fund with JPY and CHF. To round it out, she used her remaining credit lines (in short-term USDs) to buy a portfolio of modern "masterpieces" by Lucien Freud and Damien Hurst along with a couple of renaissance-era triptychs.

She was living large, flying private to this island of hers or that, and on this particular day was freshening up in bath of some vintage Krug, when the Big Black Swan came swaggering past, and asked to have a look at her positions. Proud, and unmodestly she bared all. The Swan (who really wasn't black, but actually was a dusky grey) said to the pig: "Little pig, little pig...I was just wondering but, errr, do you think that portfolio of yours will withstand a bit of huffing puffing??" "Oh yes," she replied, it's made for precisely that..." "You see it's actually a very conservative portfolio - with uncorrelated alpha sources and the best risk control against inflation and depreciation money can buy, ." "It won't fall down...not even if all the buildings in western China fall down. In fact, IF they do, it will boom even more when they rebuild them!" the third pig laughed. The Swan shrugged his wings (for he'd heard this before). "Well, Shit still happens" honked the Swan, as he walked away, but not before clucking: errr "What happens should real rates rise or ...?!?!"


Rahul Deodhar said...

By Lord!
You expressed it very well!! Fantastic as usual - I am a regular reader and a fan!

A whole lot of streeters are underestimating the scale and depth of this crises. But I guess thats the way it always is!


Etz3l said...

Thanks for a good laugh!

Anonymous said...

Lovely fable. Aesop could not have done better. Clearly the piggies did not study Tertullian's reason for believing in the supernatural.

certum est quia impossibile est - it is certain because it is impossible.

Macro Man said...

Superb. Your forgot the bit, however, where the National Bank of Swineland offered to take all the pigs' investments off their hands and provide genuine currency in exchange with only the smallest of haircuts.

Meanwhile, the Diet of Hogs announced that it wouldn't bail anyone out, but raised taxes on the Black Swan and the Big Bad Wolf (neither of whom did anything wrong), just in case....

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