And demand for hedging strategies that use equity options has soared at Swan Global Investments in recent months, given the uncertainties caused by the coronavirus, upcoming presidential election and U.S. economic recovery, said Randy Swan, president of the Durango, Colorado-based firm which manages $2.6 billion.
“The tide of adviser and institutional interest is rising due to broader acknowledgment that the traditional 60/40 portfolio construction will likely not replicate historic performance going forward,” Swan said.
Options Hedge
Swan is a longtime skeptic of Modern Portfolio Theory, which was made famous by economist Harry Markowitz in the 1950s and is the thinking upon which the 60/40 mix is based. Two decades ago, Swan created a strategy of using long-term put options plus buy-and-hold positions in the S&P 500 to limit huge losses during economic downturns.
That approach has since been expanded to include positions in exchange-traded funds indexed to small cap stocks, and developed and emerging markets. It relies on constant allocations of 90% to equities and 10% to put options purchased on the underlying ETF portfolio.
“Modern Portfolio Theory is part of a solution, but not the entire solution, because it doesn’t deal with market risk directly,” he said. “It relies on different asset classes to be inversely correlated, which we know doesn’t always happen.”
Chinese government bonds are another option for investors, given low returns on Treasuries, according to Eric Stein, co-director of global income at Eaton Vance Corp., and Rob Waldner, Invesco’s chief fixed-income strategist. Eaton Vance is long Chinese duration, mostly via interest-rate swaps, while Invesco is buying onshore government bonds denominated in renminbi.
It’s “actually one of those things that you can buy, where you can get some upside,” Waldner said.
Meanwhile, Glenmede’s Daly and other money managers are lamenting the lack of choices available for hedging portfolios, as well as the risks to do so. For instance, “currencies are an advanced trade that requires speculation, and few are good at it,” said Phil Toews, chief executive of Toews Corp., which oversees $1.9 billion from New York.
Many fund managers and investment advisers are forced by mandate to stick with an allocation to U.S. bonds, even though the prospects for returns are poor. When all is said and done, they may not regret missing out on the hunt for alternative hedges. With yields anchored by the Fed for the foreseeable future, Treasuries can still bring stability to a portfolio -- if not make up for a rough patch in stocks.
“That might not be a terrible thing in the short term if stocks turn lower,” Toews said. “We could enter into a market where losing nothing is the best-performing asset.”
-With assistance from Sally Bakewell.
This article was provided by Bloomberg News.