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What Return Are You Targeting?

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Setting Expectations with an Appropriate Benchmark

One of the more fre­quent ques­tions we receive at Swan Glob­al Invest­ments is,

What is the appro­pri­ate bench­mark for the Defined Risk Strat­e­gy?”

It’s a legit­i­mate ques­tion. The Defined Risk Strat­e­gy (DRS) is a unique solu­tion and stan­dard off-the-shelf indices aren’t ide­al bench­marks. It is impor­tant to remem­ber our goal is to out­per­form both the S&P 500 and a bal­anced equity/bond port­fo­lio over a full mar­ket cycle, which by def­i­n­i­tion includes both a bull and bear mar­ket. How­ev­er, a full mar­ket cycle can take quite a long time to unfold. Just wit­ness our cur­rent bull mar­ket, now in its ninth year.

So, how should the DRS’s per­for­mance be eval­u­at­ed over short­er peri­ods of time?


Setting an Appropriate Target

We believe that our Tar­get Return Band is a very appro­pri­ate prism through which our per­for­mance can be viewed. The three main ele­ments of the Defined Risk Strat­e­gy are rep­re­sent­ed in the Tar­get Return Band:

  1. A long, buy-and-hold posi­tion in ETFs, typ­i­cal­ly rep­re­sent­ing 85%-90% of the port­fo­lio (bur­gundy line)
  2. Long-dat­ed put options used to hedge mar­ket risk (gold line)
  3. Short-term, mar­ket-neu­tral pre­mi­um col­lec­tion trades to gen­er­ate cash flow (blue range)


Swan DRS Target Return Band | Swan Blog


The main idea is that at any giv­en return lev­el of the S&P 500, the DRS’s return should fall either with­in or above the blue range. If our returns fall with­in this tar­get­ed return band in the short­er-term (one year), we believe we will be on track to beat both the mar­ket and a bal­anced equity/bond port­fo­lio over a full mar­ket cycle.

Let’s break­down this bench­mark fur­ther.


Targeting Returns

First, we start with the bur­gundy col­ored line. This diag­o­nal-like line rep­re­sents the return pro­file of the S&P 500.

This ele­ment is sim­ple and straight-for­ward: It rep­re­sents a long posi­tion in pas­sive­ly-man­aged ETFs. An invest­ment in a S&P 500-based mutu­al fund or ETF seeks returns that cor­re­spond sub­stan­tial­ly to the returns of the S&P 500 index[1].

Target Return Band - Return Profile of S&P 500 | Swan Blog

Hedging to Improve Return Targets

The prob­lem with this kind of pas­sive, buy-and-hold approach is that it has unlim­it­ed down­side risk. The mar­ket can sell off by 20%, 30%, 40% or more and has done so many times through his­to­ry. Such loss­es can be cat­a­stroph­ic and require years for a port­fo­lio to recov­er.

To pro­tect against these types of major loss­es, the sec­ond com­po­nent of the DRS is to over­lay the ETF posi­tions with put options to hedge against down­side risk.

The return pro­file of this com­bined equi­ty-and-hedge posi­tion is seen in the gold line below:



The gold line lags the S&P 500 in up mar­kets but is still upward slop­ing, so the DRS’s poten­tial upside cap­ture is not capped.

In down mar­kets, how­ev­er, the val­ue of the hedge is read­i­ly evi­dent. As the S&P 500 drops, the hedged equi­ty posi­tions flat­ten out. At a cer­tain point, the slope of the curve is flat or 0, mean­ing that the hedged equi­ty posi­tion is insu­lat­ed from fur­ther loss­es in the mar­ket. The val­ue of down­side pro­tec­tion is clear and is explored in-depth in pre­vi­ous blog posts on avoid­ing large loss­es and the impor­tance of dis­tri­b­u­tion of returns.

That said, in a flat or up mar­ket the hedge does act as a drag on per­for­mance.


Targeted Returns for Cash Flow

The third ele­ment to the Defined Risk Strat­e­gy is the short-term, mar­ket-neu­tral pre­mi­um col­lec­tion trades. These are meant to be an addi­tion­al source of return that is not depen­dent on the over­all direc­tion of the mar­ket.

The impact is seen by over­lay­ing the pre­mi­um col­lec­tion trades on top of the hedged equi­ty posi­tion and is rep­re­sent­ed by the blue band below:


While the pre­mi­um col­lec­tion trades add a bit of uncer­tain­ty to the equa­tion, more often than not, these trades have been a net pos­i­tive to per­for­mance and have boost­ed the DRS’s returns above what would have been expect­ed by just the hedged equi­ty com­po­nent alone.

The upper range of the blue band rep­re­sents the aver­age annu­al return gen­er­at­ed by the income com­po­nent through­out the his­to­ry of the DRS.

How­ev­er, there have been times when the income trades have been detri­men­tal to the DRS’s per­for­mance. The low­er range of the blue band is defined by the worst sin­gle-year return of the income trades.

By using the aver­age income return to define the upside and the his­tor­i­cal worst return to define the down­side, the blue band is a more con­ser­v­a­tive way of antic­i­pat­ing the DRS’s over­all returns.


The Target Return Band as a Short-Term Benchmark

We believe the tar­get­ed return band is the most appro­pri­ate short­er-term bench­mark for the Defined Risk Strat­e­gy.

In any giv­en year, it is our goal that returns of the DRS will be with­in or above the blue shad­ed area. In 20 of the 21 years, they have been.

Target Return Band - 2017 - Swan Blog


The one year where the DRS’s returns fell out­side its expect­ed return range was 2003. That year Swan stepped out­side its nor­mal invest­ment phi­los­o­phy and came into the year with the port­fo­lio over-hedged, which exposed it to the risks of tak­ing a direc­tion­al bet on the mar­ket.

  • The pri­ma­ry les­son of 2003 was that the DRS shouldn’t take a direc­tion­al view of the mar­ket and should stick to its core invest­ment phi­los­o­phy of avoid­ing mar­ket tim­ing and stock selec­tion.
  • The sec­ondary les­son of 2003 was that it is much more impor­tant to avoid major loss­es than to cap­ture all of the upside. The DRS’s strong per­for­mance through the bear mar­ket of 2000-02 more than com­pen­sat­ed for the lag in 2003’s up mar­ket.


Targeted Returns Across Asset Classes

The Tar­get Return Band dri­ves our think­ing when it comes to apply­ing the DRS to oth­er asset class­es as well.

The DRS has almost two decades of live, ver­i­fied results uti­liz­ing U.S. large cap stocks.

In recent years, Swan has been apply­ing the DRS to oth­er asset class­es like U.S. small cap, for­eign devel­oped, emerg­ing mar­kets, gold, and long-term Trea­suries. In all of these cas­es, the Tar­get Return Band has been very accu­rate in judg­ing the actu­al or sim­u­lat­ed results of apply­ing the DRS to oth­er asset class­es.


Investing in a Myopic Marketplace

It is our opin­ion that too much empha­sis has been placed upon “beat­ing the mar­ket”.

The short-ter­mism or pre­oc­cu­pa­tion with com­par­ing per­for­mance against the S&P 500 on a year­ly, quar­ter­ly, month­ly, and/or dai­ly basis mir­rors the myopic focus that many com­pa­ny ana­lysts have on indi­vid­ual com­pa­nies beat­ing their quar­ter­ly earn­ings esti­mates. The inher­ent risk in such an approach is that one may start to lose the for­est for the trees.

At Swan, our objec­tive is to out­per­form over the full mar­ket cycle, rather than to ‘beat the mar­ket’ in any short-term peri­od. We believe achiev­ing returns with­in the tar­get­ed return band year after year can lead to long-term suc­cess.

Investors gen­er­al­ly have goals that require years or even decades to accom­plish. With such longer-term hori­zons, we believe the goals of an investor should mir­ror the goal of the DRS: to pro­duce sta­ble, con­sis­tent results. Over our 20-year his­to­ry, that is exact­ly what we have strived to achieve.


To learn more about Swan’s DRS invest­ment approach, past per­for­mance, or how it may fit into a port­fo­lio, please con­tact Swan at 970–382‑8901.


Marc Odo, Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Director of Investment Solutions - Swan Global InvestmentsAbout the author: Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Client Port­fo­lio Man­ag­er, 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.



[1] It should be not­ed that the large cap Defined Risk Strat­e­gy uses an equal-weight­ed sec­tor approach to its long posi­tions, rather than the cap­i­tal­iza­tion-weight­ed method­ol­o­gy of the S&P 500. This can lead to some dis­per­sion in per­for­mance.


Impor­tant 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, 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 S&P 500 Index is a mar­ket cap weight­ed index of 500 wide­ly held stocks often used as a proxy for the over­all U.S. equi­ty mar­ket. 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 vis­it   223-SGI-053118

By |2018-10-02T10:54:04+00:00June 4th, 2018|Blog|Comments Off on The Target Return Band