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By Opalesque Geneva:

Daniel Gelernter, in his dual capacity as a family office investment manager and director of artificial intelligence at R.G. Niederhoffer Capital Management, has spoken to many allocators. Most of them, he says, want to bring their portfolio's correlation to zero or find uncorrelated assets, that is, investments that have little or no correlation to traditional asset classes like stocks and bonds. But there isn't necessarily a thinking of why that is desirable, he says during a recent SkillsLab webinar on Opalesque.

What allocators don't mention, however, is the idea of inversely correlated, that is, negatively correlated products that move against the risk assets in your portfolio or against risk assets more broadly. These assets tend to be poorly understood, and therefore, under-allocated. But, he believes, they are the most powerful single lever to most portfolios. This theory led to his publishing a white paper on the matter in June.

The myriad of new investment approaches out there are all based on the grandfather of portfolio theory, Harry Markowitz, whose MPT theory transformed investment strategies by focusing on entire portfolio performance rather than individual stocks. Indeed, he posited that assets need to be analysed in combination rather individually, and that diversification through varying correlation increases return. The goal is to maximize return per unit of risk. All in all, there's a mathematically ideal allocation size for each asset. The concept of the Sharpe ratio, for example, which was published after the MPT, works harmoniously with his principles, along with other ways to measure the risk-adjusted rate of returns. All portfolio managers owe a great deal to Markowitz' thinking - even if they are unaware of it.

The goal is to optimise for a crisis

While Gelernter accepts almost all of what Markowitz says, he wants to add an extension to it, which "is a question of what we mean when we're optimizing our portfolio or for what times we are optimizing our portfolio." In what he would call Panic Portfolio Theory, his first premise is that real investment opportunities come from market crises, not normal times.

When we design a portfolio, he explains, we do it assuming it will operate in market normalcy and will weather the storms of market abnormality. But it should be done the other way around. As a market crisis is a crisis of liquidity, and real correlations is higher than modelled and real liquidity is lower, we have less liquidity and more leverage in our portfolios than we think - and are more susceptible to crisis than we think. He proposes we treat all non-liquid investments as perfectly correlated to risk assets. "In panic portfolio theory, the object is not to weather a storm, but rather to look forward to the time of an approaching storm because that will be the best time for your portfolio."

Instead of putting your money to work in low volatility markets and beat your benchmark, he suggests that while keeping up with the benchmark, you use excess return from the benchmark to put on the protective element. This "will allow you to return a multiple of your portfolio when there is a serious panic at hand, because that's when the best buying opportunities occur."

"Markets haven't really become more dangerous, it's just that we haven't gotten any better at dealing with danger and every generation, at least, we end up in a crisis scenario that relatively few of us are prepared to meet, and a lot of portfolios are wiped out in the process."

In the reminder of the webinar, using live demonstrations and real crisis data, Gelernter explores:

* The physics of market panic and how self-stabilizing systems become chaos machines (using the analogy of damping systems in physics).
* Why most "protective" strategies are trend-following in disguise.
* The three non-negotiable elements of real protection: true liquidity, negative correlation, and volatility as a friend.
* Case studies from the 2025 Liberation Day crash and the 2023 bond reversal.
* A mathematical framework for evaluating any protection strategy.

You can watch the full webinar replay here.

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Next SkillsLab webinars:

About: Why the next decade's best returns won't come from predicting commodity prices - they'll come from identifying superior execution in energy, materials, infrastructure, and industrial equities.
When: Thursday, November 20th at 11 am ET
Who: William Thomson, head of Massif Capital
Free registration: www.opalesque.com/webinar/index.php?id=87#pw87

About: Applying institutional discipline to the frontier of blockchain venture: Lessons from Europe's largest blockchain venture allocator
When: Wednesday, December 10th at 11 am ET (4pm GMT, 5pm CET, 6pm Riyadh, 7pm Dubai, 8:30pm Delhi)
Who: Ruud Smets, partner & CIO, and Leopoldo Ochoa, investment associate at Theta Capital Management B.V.
Free registration: www.opalesque.com/webinar/index.php?id=87#pw87