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The Case for the DRS as a Total Portfolio Solution

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Where the Defined Risk Strategy Fits

When Randy Swan first devel­oped the Defined Risk Strat­e­gy (DRS) in 1997, it was designed to be a total port­fo­lio solu­tion. Randy start­ed invest­ing at an ear­ly age and tried many of the strate­gies avail­able: buy-and-hold, mar­ket-tim­ing, stock-pick­ing, tra­di­tion­al diver­si­fi­ca­tion, etc. Those strate­gies did not pre­vent him from feel­ing the pain of the 1987 “Black Mon­day” crash or the 1990–1991 reces­sion. It wasn’t until he start­ed work­ing with insur­ance com­pa­nies while at KPMG that he struck upon the ideas that would one day become the DRS.


A Strategy Built for Different Market Environments

A suc­cess­ful mon­ey man­ag­er might be in busi­ness for decades. Alter­na­tive­ly, suc­cess­ful insur­ance com­pa­nies have been around for cen­turies. Ulti­mate­ly, an insur­ance com­pa­ny bears the risk of pol­i­cy claims, and its bal­ance sheet must be strong enough to with­stand those claims when they come in. A suc­cess­ful insur­ance com­pa­ny must invest their assets well, be very cog­nizant of the prob­a­bil­i­ties of unfa­vor­able out­comes, and gen­er­ate suf­fi­cient rev­enue in order to stay in busi­ness. Suf­fice to say, a hit of 30% or more to its bal­ance sheet could be cat­a­stroph­ic.

Many of those insur­ance prin­ci­ples are seen in the DRS:

  1. Expo­sure to the equi­ty mar­kets is main­tained via low-cost ETFs, with­out any attempt to out­smart the mar­ket via stock selec­tion or mar­ket tim­ing.
  2. Down­side risk is mit­i­gat­ed via the hold­ings in long-term put options.
  3. Rev­enue is gen­er­at­ed from the pre­mi­um col­lec­tion trades.

DRS Three-Step Process

These three pri­ma­ry build­ing blocks are com­ple­men­tary and seek to pro­vide a source of returns in just about any mar­ket envi­ron­ment. After all, the mar­ket can do one of three things: it can go up, it can go down, or it can stay flat. The first com­po­nent, equi­ty, does well when mar­kets go up. In the sec­ond com­po­nent, the hedge gains val­ue if the mar­kets go down. With the third com­po­nent, if the mar­kets stay flat and range bound in a short time hori­zon, the pre­mi­um col­lec­tion trades tend to do well.

DRS Process Seesaw

It can be said with a high degree of cer­tain­ty that in no envi­ron­ment will all three com­po­nents pos­i­tive­ly con­tribute to per­for­mance. How­ev­er, in any giv­en envi­ron­ment, at least one, if not two, of the three com­po­nents may con­tribute pos­i­tive­ly to the DRS.

This, of course, is by design and is a man­i­fes­ta­tion of a tru­ly diver­si­fied strat­e­gy.

To damp­en over­all port­fo­lio volatil­i­ty, the indi­vid­ual com­po­nents need to have a low or neg­a­tive cor­re­la­tion. His­tor­i­cal­ly speak­ing, the hedge com­po­nent has been neg­a­tive­ly cor­re­lat­ed to both the equi­ty posi­tion and the income trades, and the income trades have had a low cor­re­la­tion to the equi­ty stake.


A Time-Tested Strategy

Over the course of its 20-year his­to­ry, the DRS has seen many dif­fer­ent mar­ket envi­ron­ments and events, includ­ing:

  • The Long Term Cap­i­tal Man­age­ment bust and Russ­ian default in 1998
  • The “irra­tional exu­ber­ance” of the dot-com bub­ble
  • The sub­se­quent burst­ing of the dot-com bub­ble and the long bear mar­ket of 2000-02
  • The Sep­tem­ber 11th ter­ror­ist attacks
  • The 2008 mar­ket col­lapse, the most severe bear mar­ket since the Great Depres­sion
  • The sec­ond-longest bull mar­ket in U.S. his­to­ry, start­ing in March 2009
  • The “flash crash” of May 2010
  • The debt down­grade of August 2011
  • A 32.4% gain in the S&P 500 in 2013

Through­out a two-decade peri­od that encom­passed many peaks and val­leys, the 100% Swan DRS Select Com­pos­ite out­per­formed both the S&P 500 and a 60% equity/40% bond port­fo­lio. Even though the cur­rent bull mar­ket is in its eighth year and is the sec­ond-longest bull mar­ket in U.S. his­to­ry, the down­side pro­tec­tion the DRS gen­er­at­ed through the bear mar­kets of 2000-02 and 2007-09 have com­pen­sat­ed for its under­per­for­mance rel­a­tive to the S&P 500 dur­ing the last sev­er­al years.

Only the most opti­mistic and fool­ish investors would argue that bear mar­kets have been ban­ished for­ev­er.

When the next bear mar­ket does arrive, the DRS will be pre­pared.

Q2 2018 - Defined Risk Strategy - Mountain Chart - Swan Global Investments

Source: Swan Glob­al Invest­ments and Morn­ingstar; the Bar­clays U.S. Aggre­gate Bond Index and the S&P 500 Index are unman­aged indices, and can­not be invest­ed into direct­ly. Past per­for­mance is no guar­an­tee of future results. Swan DRS results are from the Select Com­pos­ite, net of fees, as of 6/30/2018. Struc­tures men­tioned may not be avail­able with­in your Broker/Dealer.



All that said, we real­ize that most investors are unable or unwill­ing to invest 100% of their mon­ey with the DRS. The DRS can still per­form a con­struc­tive role with­in a port­fo­lio either as a core equi­ty solu­tion, as a dis­tri­b­u­tion vehi­cle, or as a cap­i­tal preser­va­tion vehi­cle.


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.




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  324-SGI-080618

By |2018-11-13T12:52:31+00:00May 26th, 2017|Blog|Comments Off on Where the DRS Fits: The Case for the DRS as a Total Portfolio 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.