Wednesday, October 26, 2011

Are So Called "Catastrophe Portfolios" Sufficiently Leveraged For A Deep Crisis?

A recent Reuters article stated that "The Rich Are Running For Cover As Turmoil Hits Wealth". It describes how some wealthy families have embarked on damage limitation rather than seeking to boost their fortunes. However, the "catastrophe portfolio" as described by Ivan Adamovich, head of the Geneva operations of Swiss bank Wegelin, seems more of a difficult times portfolio than a catastrophe portfolio. It allocates one third of money to gold, one third to defensive and internationally diversified blue chip company shares and a third to the debt of ultra safe developed countries.

In my opinion, this portfolio does not provide nearly enough protection in the event of a deep crisis.

1) The allocation to gold may or may not work out well in a global economic crisis. Gold is not a crisis proof investment. Unlike basic necessities needed for survival, the value of gold is artificial. It is desirable because it is scarce and because we think it can be resold for an even higher price than it's purchase price. However as pointed out over at Business Insider, "think of a financial crisis as basically a period in which everyone is scrambling to raise money to pay their debts. There's basically no gold-denominated debt (as fas we know). Thus gold is a really great thing to sell (to raise cash). Very few people have an acute need to own more of it".

2) Stocks for traditional defensive plays and internationally diversified blue chip companies will get trashed in a deep crisis and do not provide any protection at all.

3) I question whether there is really such a thing as "debt of ultra safe developed countries". As shown in this list from Wikipeia of countries by external debt, developed countries for the most part are carrying high debt loads and a world wide bout of inflation causing bonds to lose value is a possible consequence of a deep crisis.

Thus, while this so called catastrophe portfolio is not terribly risky if the world wide economy continues to muddle along, I am doubtful that it would perform particularly well in a deep crisis. My model catastrophe portfolio would be much more highly leveraged, and also much riskier.

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