The Foie Gras Bubble

July 27, 2013

James Montier is one of my must reads, and he had a phrase in this piece that stood out – “the foie gras bubble”.  He was referring to investors being “force fed higher risk assets at low prices.”  Unfortunately I Googled the phrase and learned there is such a thing as foie gras bubble gum.  Hard to unlearn that.

Here is a chart and quote before the download:

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So what is an investor to do? I believe there are at least four (possibly not mutually exclusive) paths an investor could go down to try to avoid this outcome:

(i) Concentrate. Simply invest in the highest-returning assets. This is obviously risky as you become dependent upon the accuracy of your forecasts, and right now nothing is outstandingly cheap so you are “locking in,” at best, fair returns (assuming you wanted to have a portfolio that was 100% invested and split between, say, European value and emerging market equities). You are, however, giving up the ability to rebalance.

(ii) Seek out alternatives. This meme had been popular until the GFC revealed for all to see that many alternatives were anything but alternatives. True alternatives may be fine, but they are likely to be few and far between.

(iii) Use leverage. This is the answer from the fans of risk parity. Our concerns about risk parity have been well documented. As a solution to a low-return environment, leverage seems like an odd choice. Remember that leverage can never turn a bad investment into a good one, but it can turn a good investment into a bad one (by forcing you to sell at just the wrong point in time).

(iv) Be Patient. This is the approach we favour. It combines the mindset of the concentration “solution” – we are simply looking for the best risk-adjusted returns available, with a willingness to acknowledge that the opportunity set is far from compelling and thus one shouldn’t be fully invested. Ergo, you should keep some “powder dry” to allow you to take advantage of shifts in the opportunity set over

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