When There’s No Pain, There’s No Premium In Investing

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In his recent interview with Tobias, Corey Hoffstein discusses his no pain, no premium investing strategy, saying:

Corey: So this is one of those, it goes back to the old, “No pain, no gain.” It’s just a play on that, but at the end of the day it goes back to this risk-based mindset we were talking about at the beginning, which is a lot of people are `pursuing returns, and I think often forget that the null hypothesis is that expected return comes from bearing some sort of risk.

Whenever you’re evaluating a strategy or a trade, or anything, you should be asking, “What is the risk that I’m bearing or conceptually bearing, that someone else wants to get rid of this, I’m willing to buy it, am I being paid enough for that risk if that risk occurs?”

I think all too often, we get caught up in the pursuit of return and the potential alpha something generates, but I think when you look at things through a risk-based lens, you really start to be able to build potentially better portfolios by looking at, “Okay, what risks am I ensuring when I buy equities? What risks am I ensuring when I buy bonds, commodities? What risk am I ensuring when I buy a carry strategy? When I do trend following, and how do these all interplay with each other to create a more consistent return profile?”

I do think it ultimately, to me, the most interesting philosophical aspect of the “No pain, no premium.” mentality is that diversification taken to its extreme limit. There still has to be pain left over. If you diversify away all the pain, all you should expect to earn is the painless return, which is the risk free rate. Your risk free U.S. short term government bonds, if you think U.S. government bonds are risk free.

So there’s some limits here, theoretical, philosophical limits as to how much pain you can ultimately get rid of, and as tough as it is to say, “Hey, I’m going to subject my portfolio to day-to-day volatility and once in every while there’s going to be some shock.” That is the pain that allows you to harvest the long term return premium, and I think it’s really important to keep that in the back of our minds.

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