Should one of the most important underpinnings of modern finance be thrown out the window because of political instability? One noted fund manager says so and he talks numbers about where he thinks there are opportunities in the current environment.
Much of portfolio theory hinges on the concept of what's known as the "risk-free rate". That's the rate of return from safest investment anyone can make. And, for generations, the safest investment was government bonds in countries such as the United States.
The risk-free rate is a very serious idea for pretty much all the financial modeling that goes on in the world today. That's not an overstatement, either.
The basic capital asset pricing model (CAPM) uses the risk free rate as in its equation. According to CAPM, a properly priced asset (such as a stock) should give investors a return equal to the risk-free rate plus a premium based on its sensitivity to the overall market's risk. When investors talk about a stock's alpha or beta, they're usually referring to variables in the CAPM.
The Fama-French model, co-created by recent Nobel laureate Eugene Fama, challenges CAPM's relative simplicity by added more variables. But even Fama-French requires the risk-free rate as an input.
So, when a fund manager says the risk-free rate is a thing of the past, that's a strong statement. When that fund manager is at Pimco, the world's largest bond fund, it's to be taken seriously.
Ben Emons, portfolio manager at Pimco, recently authored a book titled, "The End of the Risk Free Rate". He talks with Talking Numbers about the more practical aspects of where opportunities may lie in this current economic climate.
To see what Emons has to say about the current bond market, gold, and what market he thinks is attractive, watch the video above.
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