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Managing Expectations2018-09-27T17:09:40+00:00

Evaluating The Defined Risk Strategy

Human behav­ior, much like mar­kets, is cycli­cal. Often, as a lengthy benign or bull peri­od per­sists, a sense of com­pla­cen­cy begins to creep into the mar­kets.

After near­ly ten years since the Glob­al Finan­cial Cri­sis, mem­o­ries have start­ed to fade and lessons learned are being for­got­ten.  Through­out 2017, the VIX, com­mon­ly described as “the fear gauge,” was a low lev­els and reached a his­toric low in Octo­ber. Then, in Jan­u­ary of 2018, a sud­den and his­toric spike in the VIX cou­pled with a 10% cor­rec­tion for the S&P 500 Index served as a reminder of mar­ket risk.

In our opin­ion, the per­fect time to con­sid­er what investors can do about mar­ket risk is before mar­kets sell-off.

One of the best ways to help investors under­stand the Defined Risk Strat­e­gy (DRS) and to form rea­son­able expec­ta­tions for how our strat­e­gy per­forms in mar­ket sell-offs is to exam­ine the DRS per­for­mance in pre­vi­ous peri­ods of mar­ket duress.

Performance Analysis in Various Market Environments

Drawdown analysis of the Swan Defined Risk Strategy - Managing Expectations - Swan Global Investments

Portfolio Protection Starts with Understanding Bear Markets and Black Swans

  • Mis­con­cep­tions about bear mar­kets, port­fo­lio strate­gies, and risk
  • Assess­ment of risk man­age­ment via asset allo­ca­tion alone
  • The rede­f­i­n­i­tion of risk as the sever­i­ty, fre­quen­cy and dura­tion of port­fo­lio loss­es,  not sim­ply as volatil­i­ty
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Drawdown analysis of the Swan Defined Risk Strategy - Managing Expectations - Swan Global Investments

Managing Expectations — Drawdown Scenarios and Swan DRS Performance Analysis

  • Define key char­ac­ter­is­tics of every mar­ket draw­down: Speed, Mag­ni­tude, and Dura­tion
  • Explore dif­fer­ent vari­ables that impact the per­for­mance of the DRS dur­ing draw­downs
  • Analy­sis of his­tor­i­cal exam­ples of both favor­able and unfa­vor­able draw­down sce­nar­ios for the DRS Select Com­pos­ite since 1997
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Analysis of Three Largest Drawdowns - Swan Defined Risk StrategyDRS — Swan Glob­al Invest­ments” />

Analysis of Three Largest Drawdowns — Swan Defined Risk Strategy

  • The Defined Risk Strat­e­gy Select Com­pos­ite
  • Three worst draw­downs since incep­tion July 1, 1997
  • Rel­a­tive moves ver­sus the S&P 500 Index
  • Analy­sis of mar­ket con­di­tions and DRS per­for­mance
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Risk Analysis & Software

It’s tough to make pre­dic­tions, espe­cial­ly about the future.” — Yogi Berra

In the wake of the Glob­al Finan­cial Cri­sis of 2007-09, numer­ous sta­tis­ti­cal tools became avail­able that attempt to quan­ti­fy the risk to a port­fo­lio under adverse sce­nar­ios. Broad­ly speak­ing, these types of tools attempt to esti­mate future risk fol­low­ing one of two meth­ods:

  1. Hold­ings-based
  2. Returns-based

Each has their rel­a­tive strengths and weak­ness­es. Nei­ther is per­fect.

Risk Analysis Software Considerations & The Defined Risk Strategy

  • Define Hold­ings-Based Analy­sis (HBS) vs. Returns-Based Analy­sis (RBA) vs. track record stress tests
  • Ana­lyze the pros and cons of each approach
  • Assess effi­ca­cy of these mod­els in fore­cast­ing future risk specif­i­cal­ly with regard to options-based strate­gies like the Defined Risk Strat­e­gy
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Analysis of the Defined Risk Strategy’s Options Premium Component

Beyond the two tra­di­tion­al tools for return gen­er­a­tion used in port­fo­lio con­struc­tion, bonds and stocks, oth­er “options” have arisen for investors – option-based strate­gies.

Option-based strate­gies seek to define the risk and reward over a par­tic­u­lar time frame and/or seek to gen­er­ate cash­flow; they have proved them­selves a use­ful tool in mar­ket envi­ron­ments that were dif­fi­cult for equi­ties, bonds, and oth­er liq­uid assets.

White Paper - Seeking Options - Defining and Managing Risk with Options-Based Strategies - Swan Global Investments

Seeking Options: Defining and Managing Risk with Options-Based Strategies

  • Assess­ment of the rise of options-based strate­gies in the mar­ket­place
  • Analy­sis of effi­ca­cy of options-based strate­gies to enhance port­fo­lio risk and reward met­rics
  • Analy­sis of effi­ca­cy of var­i­ous options-based risk pre­mi­um strate­gies to gen­er­ate cash flow
  • Per­for­mance analy­sis of options-based strate­gies vs. indi­vid­ual stocks 2003–2013
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Harvesting Risk Premia with the Defined Risk Strategy

  • While we believe it is pru­dent to always be pre­pared for a bear mar­ket, there is a car­ry­ing cost to being always hedged.
  • Even though we do what we can to min­i­mize the car­ry­ing cost of the hedge, the cost will cre­ate some drag on over­all DRS per­for­mance in up mar­kets.
  • That’s where the third com­po­nent of the DRS invest­ment process comes into play.
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FAQ: The Options Premium Component of the Defined Risk Strategy

Beyond the use of options to hedge the under­ly­ing equi­ty invest­ment, the third com­po­nent of the DRS invest­ment process involves an active­ly-man­aged, mar­ket-neu­tral options strate­gies that seek to har­vest option pre­mi­um. This options pre­mi­um com­po­nent is intend­ed to help off­set the cost of the hedg­ing com­po­nent and gen­er­ate addi­tion­al return for the port­fo­lio.

As the use of options at the port­fo­lio lev­el to man­age port­fo­lio risk and/or to gen­er­ate cash flow is not as com­mon as the use of bonds, for exam­ple, advi­sors and investors might have ques­tions about this com­po­nent of the DRS. As such, we’ve col­lect­ed many of the most com­mon ques­tions to help explain the risk and rewards of this part of our invest­ment process.

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Swan Defined Risk Investing

Learn more about our dis­tinct invest­ment process, review per­for­mance, explore avail­able DRS struc­tures, and more.

*Source: Swan Global Investments and Morningstar; the S&P 500 index in an unmanaged index, and cannot be invested into directly. Past performance is no guarantee of future results. The performance numbers referenced above are used for illustrative purposes to indicate the DRS’s performance during Bear Market conditions.