Lowering Risk

You Aren't Lowering Risk
“This plan claims that it can invest the money such that it generates higher return with less risk.” Okay. How? It can’t get safer than in US Treasuries. If you switch away from those, then what? Stocks? "

~Paul F. Cwik, Ph. D.
Associate Professor of Economics
Mount Olive College

Our Response

First, Dr. Cwik is not saying that investments in US Treasuries are wise.  He is saying that our claim that we lower risk is not true.   His point, and it is shared by others, is that there is no payment risk when the government has the power to print money.  And we agree to disagree. 

We believe that we are lowering risk in three ways :

First, the model that we outline invests in higher yielding assets in a shared-risk model.  The Trust Funds assets are invested in sub-accounts which are directly tied to the benefits of people who want more risk in their benefit package.  If the higher yielding investments lose, there is an offsetting reduction to benefits of future beneficiaries.  This approach is consistent with a variable-annuity that many people buy for retirement today.  This does not eliminate risk, but does reduce it. 

Second, we believe that diversification lowers overall risk exposure.  We believe that we are trading last dollar risk in treasuries for first dollar risk in equities. 

Risk is not constant over a single investment within a single portfolio.  As asset concentrations rise so does the risk associated with the investment because to exit the entire position you have to sell larger amounts.  We separate risk into first dollar risk and last dollar risk.  First dollar risk is the risk deals with the portion of the investment which can be liquidated without creating a disruption to market liquidity.  Last dollar risk is the exposure if you have to sell the entire portfolio.  For example, I own 100 shares of KO, I can sell it entirely without disrupting the market.  If I own 7 million shares, I can't.   As the size of the position grows so does the risk.

 The Trust Fund owns 100% of its 'assets' in a single issuer which has debt levels of 500-600% of revenue.  Multiple rating agencies have downgraded the debt of that issuer.  Leading bond fund managers have expressed sufficient worry that they are short the issuer.   We believe that there is risk there, and significant last dollar risk. 

Third, even if the issuer is safe, the portfolio has 100% of its holdings in assets which have a negative correlation to unanticipated inflation.  That isn't an uncommon event.