Levered low-beta portfolios risk instability when group earnings deviate from expectations

Evidence

Fouse criticized the idea of the leveraged low-beta fund within Wells Fargo, earning Black’s ire: “I said `Well, Jeez, there’s something wrong here, guys. We’re going to end up levering utilities and food stocks, and the future earnings developments of these groups can wander away from what was expected and you’re going to find yourself in trouble.’ … Fischer Black got so angry with me … he got up and left the conference room.” (Fouse interview) 5. — Donald MacKenzie, An Engine, Not a Camera, 1488

Categorization

• SHARE: A vivid anecdote of the internal Wells Fargo fight over the leveraged low-beta fund — send to anyone interested in Black-Scholes history.
• XREF: connects to: Corporate value is unaffected by debt-versus-equity financing mix in perfect markets — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 175; Leverage amplifies percentage returns, making options riskier than underlying stock — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 535; Restricting riskless borrowing explains the empirically observed low-beta anomaly — Donald MacKenzie, An Engine, Not a Camera: How Financial…, 394 (+2 more)

Broader Connections

• Risk attitude determines how an investment’s value differs from its expected payoff #expands (0.72) — Donald MacKenzie, An Engine, Not a Camera, 534