Practical analysis for investment professionals
10 September 2015

Weekend Reads for Global Investors: Will the Fed Raise Rates and Why You Should Care

Posted In: Weekend Reads

All eyes are on the US Federal Reserve.

The Fed’s Federal Open Market Committee (FOMC) will meet next week and decide whether to raise rates this month. The New York Times provided an excellent summary of the rate’s history since 2008 and why September 2015, December 2015, and now March 2016 are the most likely dates that the Fed will make a move. Deutsche Bank’s Joseph LaVorgna cited seven reasons why he doesn’t think the Fed will raise rates next week that largely capture the sentiment on the Street at this point.

Investors are used to reading all kinds of forecasts about rate hikes. Still, you know this is a high stakes game now that a former US Treasury secretary also joined the fray and made his own prediction. Larry Summers argued on Wednesday that the Fed must hold off on a rate hike.

As for my own view, I am not in the forecasting business. Looking at the implications of the RMB devaluation a few weeks ago, however, I felt the development would offset much of the pressure for the Fed to raise rates at the upcoming FOMC meeting.

In case you are wondering why everybody cares so much about the rate hike, sufficed to say that there is a lot of money at stake. Case in point, a “black swan” fund claimed to have made $1 billion — most of it in just one day — when the stock market started its recent retreat. And if you are still not convinced, the return of the fund came to 20%!

Although some questioned the authenticity of the numbers, such returns are possible with this type of strategy. In essence, investors are paying for a lot of time decay by betting on a big downside move on (at least) one of these days. So although it is undoubtedly sweet listening to the sound of a cool billion dropping into your coffers on a very special day, you’ll more likely watch your money slip through your fingers every other day of the year. But I digress.

Hedging with such a strategy is quite costly. The more mainstream approach to managing downside risk is to dial down the exposures to equities in a multi-asset strategy portfolio. A more advanced game plan is to dial down that exposure at appropriate times, i.e., through a dynamic asset allocation strategy. Nobel laureate Myron Scholes discussed the importance of dynamic asset allocation strategies for long-term investors with me in a recent interview. One way of building a dynamic asset allocation strategy could involve forecasting risk changes. Another Nobel laureate we interviewed, Robert Engel, is the guru of that.

If all this volatility talk is getting you down, check out psychology’s latest findings on “the single biggest predictor of human happiness.” Have a great weekend and happy reading!

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image credit: ©iStockphoto.com/JLGutierrez

About the Author(s)
Larry Cao, CFA

Larry Cao, CFA, senior director of industry research, CFA Institute, conducts original research with a focus on the investment industry trends and investment expertise. His current research interests include multi-asset strategies and FinTech (including AI, big data, and blockchain). He has led the development of such popular publications as FinTech 2017: China, Asia and Beyond, FinTech 2018: The Asia Pacific Edition, and Multi-Asset Strategies: The Future of Investment Management and is a frequent speaker at industry conferences on these topics. During his time in Boston pursuing graduate studies at Harvard and as a visiting scholar at MIT, he also co-authored a research paper with Nobel laureate Franco Modigliani that was published in the Journal of Economic Literature by American Economic Association. Larry has more than 20 years of experience in the investment industry. Prior to joining CFA Institute, Larry worked at HSBC as senior manager for the Asia Pacific region. He started his career at the People’s Bank of China as a USD fixed-income portfolio manager. He also worked for US asset managers Munder Capital Management, managing US and international equity portfolios, and Morningstar/Ibbotson Associates, managing multi-asset investment programs for a global financial institution clientele. Larry has been interviewed by a wide range of business media, such as Bloomberg, CNN, the Financial Times, South China Morning Post and the Wall Street Journal.

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