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Where the DRS Fits: The Case for the DRS as a Core Equity Solution

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How the DRS Can Function as a Core Equity Position

Although the DRS was orig­i­nal­ly designed to be a total port­fo­lio solu­tion, Swan Glob­al Invest­ments real­izes it is unlike­ly that many peo­ple will place 100% of their mon­ey in the DRS.

One of the most fre­quent­ly asked ques­tions regard­ing the Defined Risk Strat­e­gy is, “Where does the DRS fit?” While it is true that the DRS can per­form many dif­fer­ent roles with­in a port­fo­lio, we tend to posi­tion the DRS first and fore­most as a core equi­ty solu­tion.

The flag­ship DRS solu­tion, with its incep­tion in July 1997, is based on large cap U.S. equi­ty. Although the DRS is now offered upon oth­er asset class­es like small cap equi­ty, for­eign devel­oped, and emerg­ing mar­kets, the flag­ship offer­ing has always uti­lized U.S. large cap ETFs for its equi­ty expo­sure. Typ­i­cal­ly, the DRS holds 85%-90% of its posi­tions in ETFs.

One can make the case that the DRS is fun­da­men­tal­ly a core equi­ty posi­tion, with the hedge and income com­po­nents over­laid on top of it.

If one were to com­pare the port­fo­lio char­ac­ter­is­tics of the Swan Defined Risk Strat­e­gy Select Com­pos­ite against the S&P 500 Index and the Morn­ingstar cat­e­go­ry for Large Blend, the DRS is right in line with oth­er core, large cap equi­ty offer­ings.

Asset Allocation - DRS as a Core Equity

Market Cap - DRS as a Core Equity Blog Valuations - DRS as a Core Equity Blog

Giv­en the fact that typ­i­cal­ly 85% to 90% of the port­fo­lio is held in S&P Select Sec­tor ETFs, these num­bers are com­plete­ly log­i­cal. The strat­e­gy does, how­ev­er, pur­sue more of an equal-weight sec­tor approach to the mar­ket. The S&P 500 is a mar­ket cap­i­tal­iza­tion-weight­ed index. The equal-weight sec­tor approach leads to a bit of a tilt to both small­er names and val­ue char­ac­ter­is­tics, which you see in the mar­ket cap and val­u­a­tion tables, respec­tive­ly. If one is a pro­po­nent of Fama-French and the belief that there is a sys­tem­at­ic val­ue pre­mi­um and a small cap pre­mi­um, the equal-weight­ed sec­tor approach is a way to empha­size those fac­tors. But there is lit­tle doubt that the port­fo­lio char­ac­ter­is­tics of the DRS are large cap, core equi­ty.

On the oth­er hand, you will cer­tain­ly see a dif­fer­ence of returns between the DRS and the S&P 500 index or the typ­i­cal large blend mutu­al fund. If one were to look at tra­di­tion­al “track­ing” met­rics like cor­re­la­tion and R-squared, you will see much high­er lev­els of dis­per­sion from the S&P 500 than you would with a tra­di­tion­al large cap core fund.

Metrics - DRS as a Core Equity Blog

This, of course, is by design. The whole intent of the DRS is to avoid those times when the mar­ket is down sig­nif­i­cant­ly. The dri­ving idea behind the DRS is that those large bear mar­kets are too painful to endure, so the DRS is engi­neered to have a dif­fer­ent risk-return pro­file than a tra­di­tion­al long posi­tion.

One of the key images we use at Swan to con­vey this mes­sage is the chart below:

Return Band - DRS as a Core Equity Blog

The diag­o­nal red line is the prof­it-loss dia­gram for the S&P 500. The curved gold line rep­re­sents the return pro­file of the DRS’s hedged equi­ty position—that is, the buy-and-hold posi­tion in the mar­ket com­bined with the pro­tec­tive ele­ments of the hedge. The gold line lags the S&P 500 in up mar­kets, but it is still upward slop­ing. In down mar­kets, the hedged equi­ty posi­tions flat­ten out as the S&P 500 con­tin­ues to drop. The blue area around the gold curve is the tar­get­ed range of impact from over­lay­ing Swan’s short-term pre­mi­um col­lec­tion trades over the hedged equi­ty posi­tion. It is our goal that returns of the DRS will be with­in or above the blue shad­ed area. His­tor­i­cal­ly, in every year but one, they have been.

In our opin­ion, the DRS allows one to have their cake and eat it too. The investor has large cap, core equi­ty expo­sure via our large hold­ings in the S&P Select Sec­tor ETFs. How­ev­er, the risk-return pro­file of those hold­ings has been altered to man­age and dimin­ish the impact of bear mar­kets.

It is this dif­fer­ence in return pat­terns and the use of options that dri­ve some to clas­si­fy the Defined Risk Strat­e­gy as an “alter­na­tive” strat­e­gy. The argu­ment for treat­ing the DRS as an alter­na­tive invest­ment will be explored in an upcom­ing blog post.

Oth­er roles we have explored in this series are:

Feel free to review more infor­ma­tion on the Defined Risk Strat­e­gy per­for­mance, or its com­po­nents, or call 970.382.8901.

For more infor­ma­tion on the Defined Risk Strat­e­gy per­for­mance, call 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®, 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 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 Glob­al Invest­ments offers and man­ages the Defined Risk Strat­e­gy for investors includ­ing indi­vid­u­als, insti­tu­tions and oth­er invest­ment advi­sor firms. All Swan prod­ucts uti­lize the Swan 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. Swan claims com­pli­ance with the Glob­al Invest­ment Per­for­mance Stan­dards (GIPS®). Any his­tor­i­cal num­bers, awards and recog­ni­tions pre­sent­ed are based on the per­for­mance of a (GIPS®) com­pos­ite, Swan’s DRS Select Com­pos­ite, which includes non­qual­i­fied dis­cre­tionary accounts invest­ed in since incep­tion, July 1997 and are net of fees and expens­es. All data used here­in; includ­ing the sta­tis­ti­cal infor­ma­tion, ver­i­fi­ca­tion and per­for­mance reports are avail­able upon request. The bench­marks used for the DRS Select Com­pos­ite are the S&P 500 Index, which con­sists of approx­i­mate­ly 500 large cap stocks often used as a proxy for the over­all U.S. equi­ty mar­ket, and a 60/40 blend­ed com­pos­ite, weight­ed 60% in the afore­men­tioned S&P 500 Index and 40% in the Bar­clays US Aggre­gate Bond Index. The 60/40 is rebal­anced month­ly. The Bar­clays US Aggre­gate Bond Index is a broad-based flag­ship bench­mark that mea­sures the invest­ment grade, US dol­lar-denom­i­nat­ed, fixed-rate tax­able bond mar­ket. The index includes Trea­suries, gov­ern­ment-relat­ed and cor­po­rate secu­ri­ties, MBS (agency fixed-rate and hybrid ARM pass-throughs), ABS and CMBS (agency and non-agency). 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 advisor’s depen­dence on its DRS process and judg­ments about the attrac­tive­ness, val­ue and poten­tial appre­ci­a­tion of par­tic­u­lar ETFs and options in which the advi­sor 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. Fur­ther infor­ma­tion is avail­able upon request by con­tact­ing the com­pa­ny direct­ly at 970.382.8901 or vis­it 143-SGI-060217[/fusion_builder_column][/fusion_builder_row][/fusion_builder_container]

By |2018-10-02T11:19:15+00:00June 5th, 2017|Blog|Comments Off on Where the DRS Fits: The Case for the DRS as a Core Equity Solution

About the Author:

As Director of Investment Solutions, Marc 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.