Might investors determine what else can become a meme and damage their portfolios in a world where anything from a pixelated flying kitten to a female watching a fire can go viral and become a meme? Because meme risk cannot be quantified, let alone assessed, “memification” will shift the equation for portfolio risk, in my opinion as a chief risk officer. However, it is manageable.
Meme risk is the outcome of investment apps that allow fractional shares to be bought and traded for little or no cost, as well as trading for amusement and participation in the online community. The dramatic price action for GameStop GME, -0.77% and AMC AMC, -3.13 percent, crowd-sourced and unattached from any financial or economic reality, has already shown glimmers of this. The so-called “Reddit rallies” are only the start. The markets will be turned into a massively multiplayer online game by social network investing groups. Thousands of people united together to defeat GameStop short sellers, much like hundreds of people gathered together to kill the invincible dragon Kerafyrm in the online game EverQuest. These groups’ goals do not have to do with a value judgment, or anything else for that matter. It could be as lighthearted as entertainment or as serious as a societal statement. Meme investors might just as easily gather together to change the price of an oil stock over time, tracing out a smokestack on the price chart. Alternatively, in honor of Taylor Swift’s birthday, raise the price of food processor JBS Swift. For some, what may be a source of entertainment will be a source of profit for others. There’s money to be earned in deception and manipulation, which obscures risk’s footprint even more. So, what can we do about a new sort of danger that appears out of nowhere, random and unpredicted, and has nothing to do with any financial or economic reality? The word “unrelated” holds the key. The most basic risk containment strategy in finance is the best weapon against this new and alien foe: diversification. Like the aliens in War of the Worlds who are destroyed by pathogens, “the humblest things that God, in his wisdom, has put upon this earth,” the most basic risk containment strategy in finance is the best weapon against this new and alien foe: diversification. As we all know, if a risk is independent, it may be diversified away and reduced to insignificance provided it represents a tiny enough percentage of the whole portfolio. When I have a sense of extreme insecurity, as if I can’t get a firm hold on the sources of risk, I instinctively boost the portfolio’s diversity. This entails stepping back from positions that are excessively weighted, as well as lowering my reliance on correlations, as there is no way of knowing how they may change. This is, however, a method that comes at a price. Assuming that all stocks are equally vulnerable to meme risk, the best way to mitigate that risk is to spread it evenly across all holdings. Outsized positions come with a higher danger of being fired. The risk of taking a large risk for a higher return must be measured against the risk of taking a large risk for a higher return. From a risk standpoint, moving toward an equally weighted portfolio will be appealing in any case. Fabric RQ’s founder and chief risk officer is Rick Bookstaber. He formerly worked with Morgan Stanley, Salomon Brothers, Bridgewater Associates, and the University of California Regents as a chief risk officer./n
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