Risk versus Reward, Leverage, and Hedging
I have been thinking about these subjects a lot lately.
Two things really made me think about it. The first was the simple work we did converting the IG indices from a series of spreads into a series of returns. The simplicity, the low volatility, yet the power of the returns made me think.
More recently, it has been the attention I have been paying to structured products, and CLO’s in particular.
I am really beginning to wonder if we have made things too complex. Do we look for relative value trades where outright risk might actually be safer?
At the same time that we seem to reward complexity, we don’t seem to like leverage. Yet maybe leverage is right in some cases?
Then we have our “hedge” products. CDS is front and center as a hedge product. As I look more closely at some of the characteristics of the “hedge” products I wonder if some of the “hedge” products should actually be the “primary” products.
Simply a Cheap Asset
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