[Stock market volatility and uncertainty represent major risks for advisors and their clients by testing investors’ resolve and their ability to stay the course to capture the effects of long-term compounding. That is why there has been a serious search for downside protection strategies that can be added to investment portfolios. This has increasingly become a major component of portfolio construction decisions for advisors and RIAs.
That is why it is very timely that a major research study—“An Advisor’s Guide to Downside Protection”—has just been published to review the dominant strategies now in use, as well as offer suggestions and advice on how to analyze and implement these defensive strategies. To better understand this research, we talked with the study creator and Institute member Jon Robinson, CEO and co-founder of Blueprint Investment Partners. In addition to investment management services, the Greensboro, N.C.-based firm provides its advisor clients with practice management solutions, including tools and coaching to help advisors implement an optimal business model/strategy to compete in our industry’s new operating environment. We were interested in exploring their research methodology and perspective on how advisors can best manage downside risk and improve client outcomes.]
Bill Hortz: What was your goal and motivation for your research on downside protection strategies? What were the key questions that you wanted your research to answer?
Jon Robinson: Ultimately, it was our conversations with financial advisors that fueled the creation of “An Advisor’s Guide to Downside Protection.” We kept hearing—and we still hear it—about the challenges they face in selecting the “right” approach to downside protection. This challenge has been significantly more difficult in environments like the last 12 years when there has been a temptation to ignore downside risk in favor of capturing the seemingly endless supply of upside.
Like any insurance policy, a downside protection strategy is one of those things advisors’ clients may not need…until they do. The whole point is to have the strategy in place before the unexpected happens, before the potentially catastrophic event occurs.
Our goal was to provide advisors with a practical field guide for considering how to manage downside risk in their client portfolios. And we wanted to explore the topic holistically, so our analysis centered on four critical questions:
1. Is the approach accessible to the average investor and their advisor?
2. How well does a particular approach diversify the traditional 60/40 portfolio to provide downside protection?
3. In addition to providing downside protection, how well does the instrument perform on a standalone basis?
4. How does each instrument influence investor behavior?
Hortz: How did you determine the 11 downside protection strategies that you chose to analyze for your study?
Robinson: Our first consideration was practical in nature. If the approach to downside protection was difficult for the advisor and their clients to invest in, then we removed it from consideration. This included non-exchange traded products, investments with high minimums, and illiquid securities. By excluding instruments with low accessibility, we further narrowed our universe requiring analysis to three macro categories and the following individual instruments:
• Traditional diversification
o Real estate investment trust (REIT) index
o Value index
o U.S. 10-year Treasury bond
o Investment-grade corporate bond index
• Hedge strategies
o CBOE Volatility Index (VIX)
o Gold
o Inverse (short) S&P 500
• Tactical and alternative strategies
o S&P 500 short-term trend strategy
o Liquid alternatives index
o Long/short index
o Managed futures index