If I'm the head of fixed income at Bear Stearns in the early 2000's, I acted exactly as a rational person should have. I came up with every reason in the world to put on as much risk as possible. I made $75 million, my company went bankrupt, and I walked away with $52 million. That's a winner.
Really if you think about it, none of them ever had any edge. They were all trading randomly. They chose a trading method with a high frequency of winners and a terrible winner to loser ratio. If you said to me "hey, I've got your daughter captive, and you need to make 20% in the next 6 months if you ever want to see her again," then I would immediately start selling options. That's because I know that option-selling provides the highest likelihood of my making 20%. According to the skewed incentives of this scenario, my making 15% and losing 100% have the same outcome- my daughter's in trouble. Well that's an officer in a publically traded financial firm- they basically have the same deal.
PAST PERFORMANCE IS NOT INDICATIVE OF FUTURE RESULTS
Wall Street Unfiltered's Mark Melin interviews David Miller of Catalyst Funds (3:01) and discusses performance and volatility with Covenant's Scot Billington (14:55).
"Moves higher and lower in a stock create volatility, which many investors fear. But not Scot Billington of Covenant Capital Management. The firm has three investment programs and has performance dating back to 1999. One of his fund's is up 176 percent year to date, while the other funds are up nearly 12 percent and 19 percent annualized performance year to date.
Billington says that in a well diversified portfolio, a high return, high volatility product can actually decrease risk because the high return product does not necessitate as large of an initial investment. This cuts down on fees and even in the case of an 80 percent drawdown, such programs, when properly risk managed, have the potential to outperform lower return products over time."
PAST PERFORMANCE IS NOT NECESSARILY INDICATIVE OF FUTURE RESULTS