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As the World Turns: Applying a Defined Risk Strategy to Foreign Developed Markets ETFs

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The World Spins Madly On

Let’s turn back the cal­en­dar a year and remem­ber where we were in sum­mer 2016.

Great Britain made the mon­u­men­tal deci­sion to leave the Euro­pean Union. Marine Le Pen was threat­en­ing to do the same in France, as well as aban­don the Euro as a com­mon cur­ren­cy. Mar­kets were ner­vous­ly watch­ing Ital­ian banks, won­der­ing if anoth­er round of bailouts was pend­ing. In the U.S., Don­ald Trump made oppo­si­tion to free trade and inter­na­tion­al coop­er­a­tion cen­tral themes of his can­di­da­cy.

How did the inter­na­tion­al stock mar­kets respond?

Between June 30th of 2016 and 2017 inter­na­tion­al stocks were up over 20%.

The 20.83% gain of the MSCI EAFE was bet­ter than the 17.90% return on the S&P 500. Grant­ed, some say a rebound in inter­na­tion­al mar­kets was long over­due. Since the Finan­cial Cri­sis of late 2007 to ear­ly 2009, the stock mar­kets of devel­oped, non-U.S. nations have lagged the S&P 500 by a wide mar­gin. It was Europe’s turn to have a moment in the sun, but pre­dict­ing it would have been dif­fi­cult if one only paid atten­tion to the neg­a­tive head­lines a year ago.

It is for this rea­son that Swan Glob­al Invest­ments unveiled its expand­ed line-up of invest­ment solu­tions over the last few years. While the Defined Risk Strat­e­gy was orig­i­nal­ly applied to U.S. large cap stocks, the line-up now includes U.S. small cap stocks, emerg­ing mar­kets, and for­eign devel­oped mar­kets.


Is Diversification Keeping Its Promises?

Multiple Asset Classes

The promise of diver­si­fi­ca­tion has always been two-fold. First, dif­fer­ent asset class­es or styles will go in and out of favor, with dif­fer­ent invest­ments typ­i­cal­ly tak­ing turns as “king of the moun­tain.” Swan believes that it is dif­fi­cult, if not impos­si­ble, to con­sis­tent­ly pre­dict which asset class will have the best returns going for­ward. Lack­ing 20/20 fore­sight into the future, the next best option is to cov­er all your bases by diver­si­fy­ing into mul­ti­ple asset class­es.

Mitigating Risk

The sec­ond promise of diver­si­fi­ca­tion is to mit­i­gate loss­es on the down­side. Unfor­tu­nate­ly, when mar­kets sell off sig­nif­i­cant­ly, cor­re­la­tions tend to increase, and glob­al mar­kets tend to go down togeth­er. Tra­di­tion­al­ly, many inter­na­tion­al man­agers sought to mit­i­gate down­side risk by rotat­ing in or out of dif­fer­ent coun­tries or regions.


The Problem with this Kind of Diversification

These two ele­ments of diver­si­fi­ca­tion, how­ev­er, require the kind of mar­ket-tim­ing that Swan has always been against. The two rea­sons for this stance are illus­trat­ed in the table below:

Callan Graph - Foreign Developed Fund - Swan Blog Post

Source: Zephyr StyleAD­VI­SOR, Swan Glob­al Invest­ments

The above table dis­plays only four coun­tries, plus emerg­ing mar­kets, but two key take-aways are read­i­ly appar­ent:

  • First of all, there doesn’t appear to be any rhyme or rea­son as to which coun­tries or regions will be the worst-per­form­ing at any giv­en time. With lit­tle rea­son, how do peo­ple time the mar­kets effec­tive­ly?
  • Sec­ond, dur­ing the worst years like 2000–2002 or 2008, we see mar­kets mov­ing down in lock-step. The high cor­re­la­tion among the mar­kets dur­ing down­turns means there is lit­tle to no risk pro­tec­tion.


The DRS and Foreign Developed Markets

This is why Swan Glob­al Invest­ments brought its phi­los­o­phy of “always invest­ed, always hedged” to both devel­oped and emerg­ing inter­na­tion­al mar­kets. When in favor, glob­al invest­ing can boost the returns of a U.S.-centric port­fo­lio. When mar­kets sell off, the DRS invest­ments are hedged to pro­tect against major loss­es.

By adding inter­na­tion­al equi­ties to Swan’s line-up, investors have access to a larg­er oppor­tu­ni­ty set. Dur­ing those times when for­eign devel­oped mar­kets are in favor (or for­eign emerg­ing mar­kets or U.S. small cap, for that mat­ter) investors can par­tic­i­pate in their ral­lies. While the past year or so has been good for for­eign mar­kets, there is no guar­an­tee that it will con­tin­ue on indef­i­nite­ly. Any of the afore­men­tioned events or new, unfore­seen crises could poten­tial­ly turn the bull mar­ket in inter­na­tion­al equi­ties into a bear. How­ev­er, by apply­ing the Defined Risk Strat­e­gy to for­eign devel­oped, emerg­ing mar­kets and U.S. small cap stocks we believe we have devel­oped the build­ing blocks to cre­ate a bet­ter glob­al port­fo­lio.


About the Author:

Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsMarc Odo, CFA®, CAIA®, CIPM®, CFP®, Direc­tor of Invest­ment Solu­tions, is respon­si­ble for help­ing clients and prospects gain a detailed under­stand­ing of Swan’s Defined Risk Strat­e­gy, includ­ing how it fits into an over­all invest­ment strat­e­gy. For­mer­ly, Marc was the Direc­tor of Research for 11 years at Zephyr Asso­ciates.




Impor­tant Notes and Dis­clo­sures:

Swan Glob­al Invest­ments, LLC is a SEC reg­is­tered Invest­ment Advi­sor that spe­cial­izes in man­ag­ing mon­ey using the pro­pri­etary Defined Risk Strat­e­gy (“DRS”). SEC reg­is­tra­tion does not denote any spe­cial train­ing or qual­i­fi­ca­tion con­ferred by the SEC. Swan offers and man­ages the DRS for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non-qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997, and are net of fees and expens­es. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®).

All Swan prod­ucts uti­lize the Defined Risk Strat­e­gy (“DRS”), but may vary by asset class, reg­u­la­to­ry offer­ing type, etc. Accord­ing­ly, all Swan DRS prod­uct offer­ings will have dif­fer­ent per­for­mance results due to offer­ing dif­fer­ences and com­par­ing results among the Swan prod­ucts and com­pos­ites may be of lim­it­ed use. All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request.
The MSCI (Mor­gan Stan­ley Cap­i­tal Inter­na­tion­al) EAFE index com­pris­es the MSCI coun­try index­es cap­tur­ing large and mid-cap equi­ties across devel­oped mar­kets, exclud­ing the U.S. and Cana­da. The MSCI (Mor­gan Stan­ley Cap­i­tal Inter­na­tion­al) Emerg­ing Mar­kets Index is designed to mea­sure equi­ty mar­ket per­for­mance in glob­al emerg­ing mar­kets. Index­es are unman­aged and have no fees or expens­es. An invest­ment can­not be made direct­ly in an index. Swan’s invest­ments may con­sist of secu­ri­ties which vary sig­nif­i­cant­ly from those in the bench­mark index­es list­ed above and per­for­mance cal­cu­la­tion meth­ods may not be entire­ly com­pa­ra­ble. Accord­ing­ly, com­par­ing results shown to those of such index­es may be of lim­it­ed use. The adviser’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advis­er invests or writes may prove to be incor­rect and may not pro­duce the desired results. There is no guar­an­tee any invest­ment or the DRS will meet its objec­tives. All invest­ments involve the risk of poten­tial invest­ment loss­es as well as the poten­tial for invest­ment gains. Pri­or per­for­mance is not a guar­an­tee of future results and there can be no assur­ance, and investors should not assume, that future per­for­mance will be com­pa­ra­ble to past per­for­mance. All invest­ment strate­gies have the poten­tial for prof­it or loss. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970–382-8901 or 216-SGI-081717

By |2018-10-02T11:11:48+00:00August 17th, 2017|Blog|Comments Off on As the World Turns: Applying A Defined Risk Strategy to Foreign Developed Markets ETFs