quiet riot
A far cry from 2020’s massive volatility, the S&P 500 cruised to a 28.7% total return in 2021 with a maximum drawdown of just 5.2% and only two daily closes more than 5% below a previous peak. The Nasdaq 100 index saw more volatility, notching a 26.6% return for 2021 with a maximum drawdown of 10.9% on the year.
After 2020’s turbulence, a quiet year for the S&P 500 in 2021
While VIX levels were stubbornly high for such a lack of movement (the VIX index averaged almost 20 on the year), price relationships in the VIX complex reflected greater calm, with only a few brief episodes of stress shown in the VIX Dashboard’s most-sensitive “purple” indicator throughout the year, and no significant signals from the slower-moving indicators.
Each of the year’s handful of mild corrections in the S&P 500 was recovered in a sharp “V” near the 5% decline mark where TCM defensive positions typically begin, a scenario where TCM strategies commonly trail equity indexes as these defensive positions are then abandoned in the recovery. For our risk-managed equity strategies, non-confirmation from the Dashboard’s slower indicators (orange and blue below) serves to keep VIX positions small and hedging cost contained. Similarly for Alpha Seeker (+11.6% YTD), this process keeps positions small during mild corrections until a larger trend asserts itself.
TCM VIX Dashboard Indicators YTD 2021
Under last year’s conditions, TCM strategies performed as expected with Tactical Beta (+23.4% YTD) and Tactical Q (+23.1% YTD) capturing more than 80% of 2021’s market gains, better than historical experience for each strategy and significantly higher than the 50% figure for hedged equity peers on the year (see chart below). Similar conditions in other indexes resulted in similar performances for EAFE Smart Index (+8.3% YTD), Hedged Yield (+2.1% May-Dec) and Legacy Navigator (+12.8% YTD) relative to their respective benchmarks, while Hedged Disruptor (-1.8% YTD) and Emerging Markets Smart Index (-4.3% YTD) struggled with the rotation away from growth throughout much of the year.
Tactical Beta vs Hedged Equity Peers, Nov 2016 - Dec 2021. Click for larger image. Hedged Equity Peers is an equally-weighted composite of JP Morgan Hedged Equity (JHEQX), Swan Defined Risk (SDRIX) and Gateway Fund A (GATEX), rebalanced monthly. Source: TCM.
static GUARD
2021’s results highlight a unique aspect of TCM’s tactical risk management approach: the stronger the S&P becomes, the lower TCM’s hedging expense tends to be. In contrast, static risk management approaches (eg, continuous exposure to put options) tend to create relatively constant expense from year to year, growing ever larger the longer a bull market persists. Ultimately, there may even come a point where the cumulative cost of this continuous protection has outstripped any realistic benefit to the investor. No investment approach is perfect, but the results of the last five years are a testament to the power of a better tradeoff between cost and protection.
Looking forward, the most obvious hurdle for markets remains the expected tightening of monetary policy. The last attempt in 2018 was quickly aborted after markets panicked, but with inflation now a clear and present danger it may not be so easy for the Fed to change course in 2022. Rather than predict the unpredictable, we’ll continue to use the message from the VIX to guide our portfolios.