TY - JOUR T1 - Managing the Downside of Active and Passive Strategies—<em>Part 1: Convexity and Fragilities</em> JF - The Journal of Portfolio Management SP - 25 LP - 37 DO - 10.3905/jpm.2019.1.112 VL - 46 IS - 1 AU - Raphael Douady Y1 - 2019/10/31 UR - https://pm-research.com/content/46/1/25.abstract N2 - In this article, the author addresses the question of how to manage a large (or small) portfolio in low interest rate conditions while equity markets bear significant drawdown risk. More generally, he explains how to build an antifragile portfolio that can weather the most extreme market scenarios without affecting long-term performance. He also discusses how active strategies systematically create or increase existing market instabilities. By analyzing in depth market behavior during past speculative bubbles and credit crises, the author aims to address these issues. In this first part of a two-part series, the author describes as faithfully as possible the major mechanisms at stake, avoiding the trap of mapping the complexity of financial markets into a single mathematical model, which would necessarily be wrong at some point. Starting from Minsky’s financial instability hypothesis, he tries to disentangle the complex relation between dynamics and randomness, including the presence of fat tails.TOPICS: Mutual fund performance, passive strategies, portfolio theoryKey Findings• Financial crises are, in their vast majority, the result of internal instabilities. Exogenous causes are minor and at best serve as triggers. They can mainly be divided into two kinds: speculative bubbles and credit bubbles.• Artificially antifragile (convex) strategies, such as trend following, portfolio insurance, momentum, and so on, are good for the marginal investor but create instabilities when used by the bulk of the buy-side industry.• It is illusory to predict the date of a bubble burst and to catch either the top of the bubble or the market trough that follows it. However, even a small insight into the probability of a crisis can be highly beneficial for long-term performance and drawdown control. ER -