Derivatives Are Honest
Having just read Warren Buffets shareholder letter, I am struck by the old adage of “do what I say not what I do”. Warren has not had great things to say about derivates in the past, relying on his mantra of “if I don’t understand it, I don’t invest in it”. Apparently he has become quite the student on derivatives. So much that he goes into a detailed explanation of how he feels the derivatives he has purchased are under-priced for their risk, and also how he is using them to provide capital to do more in his current buying spree. If he is right he has $8 billion in interest free financing, if he is wrong, about a $35 billion dollar debt. Also keep in mind the type of derivative he purchased could not be realistically purchased by an individual investor.
I think, like Warren, if you understand the derivative, it can be a very useful tool. Unfortunately you do need to do your own homework. AAA rated CDOs seemed like a good investment, when you rely on the rating. Unfortunately that proved you cannot rely on others to do the homework for you. Regardless of the market environment we are heading into, and many believe we are in for a rough ride. Consider finding a financial advisor skilled in utilizing hedging tools to manage your portfolio. Certainly some of your investments can be long term, long only, but a little diversification, even with your investment methodology, can be a good thing.