Dog Days
The S&P 500 (+3.04% Aug) and Nasdaq 100 (+4.16% Aug) both notched fresh all-time highs in August, extending their impressive run from the March 2020 COVID lows and keeping a lid on short-term VIX prices. However, judging by the elevated prices of longer-maturity hedges and a clustering of VIX index spikes over 20 during the normally quiet summer months, worry remains despite the strength in equities.
SPDR S&P 500 ETF Trust (SPY), 5-year price chart. Source: Barchart.com
This stress has not yet been acute enough to trigger hedging signals from the Volatility Dashboard, resulting in a mostly “hands off” approach to hedging during recent bouts of weakness. This method kept up-capture for Tactical Beta (+3.06% Aug) and Tactical Q (+4.26% Aug) strategies near 100% in August, while the more nimble Alpha Seeker strategy (+4.60% Aug) used both positive- and negative-beta exposures to notch its 2nd best month of 2021.
hedging helper
Effectively hedging portfolios is a challenging task that involves a careful weighing of tradeoffs. Dedicated hedges can cushion a portfolio during times of stress, but they also tend to lose value quickly while markets rise. Low-correlation exposures such as Alpha Seeker have the ability to profit regardless of the direction of broad markets, but may not be perfectly anti-correlated during every market decline.
Given their complementing characteristics, one solution may be to build a hedging exposure using both approaches. With the right vehicles in the right combination, it may be possible to construct an exposure that retains most of the benefits of hedges while greatly reducing their cost. For example, a mix of 70% Alpha Seeker and 30% TAIL (Cambria Tail Risk ETF) would have returned about the same as TAIL in the crisis month of March 2020, with significantly less drag during the strong recovery since. (see chart below)
Hypothetical portfolio comparision, May 2017 - Aug 2021. 30% TAIL / 70% Alpha Seeker rebalanced monthly. Alpha Seeker net of 1% management fee.
Faced with today’s dizzying array of risk-management strategies, perhaps the solution to the hedging riddle is to stop looking for a single solution. While there are no “one size fits all” investment approaches, the right blend of complementary strategies may make it easier for an advisor to hold dedicated hedges in client portfolios. Please feel free to contact us for a deeper discussion.