The Black Swan Theory is used to explain hard-to-predict, rare events, but how should investors cope, react, and even try to anticipate such events? In an op-ed in Institutional Investor, Ken Posner, author of Stalking the Black Swan: Research and Decision Making in a World of Extreme Volatility, argues that “investors who want to avoid Black Swan losses might want to think twice before betting on pundits’ Black Swan forecasts.”
Instead Posner advances an approach that combines the classic fundamental research approach of Warren Buffet, Benjamin Graham, and David Dodd with more recent developments in cognitive science, computational theory, and quantitative finance. Posner writes, “Fundamental research is more than financial statement analysis and valuation. At its heart, research is the study of causation, so that we can make predictions about companies, industries, or economic variables. Ignored by academics, fundamental research remains the primary method by which Wall Street analysts make investment decisions.”
Posner begins his op-ed by questioning the recent advice of pundits to load up on gold and other commodities and concludes with the following strategy for those looking to find and avoid the next Black Swan:
We’d all like to nail the next Black Swan, and placing all of your bets on inflation might seem like a tempting strategy to do so. But experienced traders know that in a world of extreme volatility, survival is the first priority. Don’t bet your whole portfolio on one strategy. Rather, consider allocating part of your portfolio to securities that would benefit from lower-than-expected interest rates and a persistent steep yield curve. Certain financial stocks might work. For example, take a look at mortgage REITs, currently trading at or below book value, some with double-digit dividend yields. Happy hunting.