For financial professionals in Denmark

A closer look at explicit portfolio protection

Steve Cain

Steve Cain

Portfolio Manager


2 Jun 2020

Key takeaways:

  • A discussion on the key attributes of a diversifying portfolio protection strategy
  • Assessing how the landscape around traditional hedging methods has changed in recent years and resulting structural considerations
  • The importance of a robust approach to protection combining various elements designed to invest when spreads are most attractive, while limiting coincidental drawdowns
Transcript Expand

What do you think a diversifying strategy should look like?

The main element of a diversifying strategy is its lack of correlation to the main elements of an investor’s portfolio. In addition, that really means that the diversifying strategy is robust to sharp downturns in the market.

What is the point of a portfolio protection strategy?

Portfolio protection is really designed to insure a portfolio against sharp drawdowns. And those drawdowns often coincide with general risk widenings in the market. The ability to have a robust portfolio and drawdowns means the ability to invest when spreads are the most attractive and not to suffer drawdowns at the same time as the rest of investors’ portfolios.

How can protection be implemented?

There are a number of elements to a protection strategy that are important. Principally, protection must insulate the portfolio from sharp drawdowns, which means having exposure to volatility in the markets and protecting against sharp liquidity-driven drawdowns. Secondly, bear markets can come in a number of forms. Sometimes they are slow and drawn out and a way to isolate a portfolio from that is having some sort of trend-following CTA-like exposure. And finally, there are catalysts around the market that often can be insured against. That type of insurance is usually the purchase of options in other asset markets. So, the combination of those three elements can give you a robust set of insurance policies against adverse movements.

Isn’t buying options a loser’s game?

Historically, people have measured the purchase of insurance via outright hedging with options as being a very expensive and a loser’s game. I believe that the supply and demand for options and volatility in general has changed dramatically over the last five years. There are now substantial supplies of volatility being sold on a regular basis by systematic investors. That has changed the balance between hedging option buyers and sellers of volatility such that options aren’t intrinsically expensive like they were in the past in my view. It is also important to recognize how you structure your option exposure, how you hedge that on a cash basis and how you take into account the negative correlation between asset market levels. Using volatility as a hedge in a portfolio does not need to be a loser’s game.

How does this all fit together?

As with any alpha strategy, the construction of a protection strategy is as much art as science. We believe the combination of a number of different approaches to insulating the portfolio against large drawdowns is important not only in keeping returns steady and increasing the sharpe ratio in a portfolio, but allowing the portfolio to be able to increase its investment exposures at the right times when markets drawdown and not to be forced into liquidation in those periods.

These are the views of the author at the time of publication and may differ from the views of other individuals/teams at Janus Henderson Investors. Any securities, funds, sectors and indices mentioned within this article do not constitute or form part of any offer or solicitation to buy or sell them.

 

Past performance does not predict future returns. The value of an investment and the income from it can fall as well as rise and you may not get back the amount originally invested.

 

The information in this article does not qualify as an investment recommendation.

 

Marketing Communication.

 

Glossary

 

 

 

Important information

Please read the following important information regarding funds related to this article.

The Janus Henderson Fund (the “Fund”) is a Luxembourg SICAV incorporated on 26 September 2000, managed by Janus Henderson Investors Europe S.A. Janus Henderson Investors Europe S.A. may decide to terminate the marketing arrangements of this Collective Investment Scheme in accordance with the appropriate regulation. This is a marketing communication. Please refer to the prospectus of the UCITS and to the KIID before making any final investment decisions.
    Specific risks
  • Shares/Units can lose value rapidly, and typically involve higher risks than bonds or money market instruments. The value of your investment may fall as a result.
  • An issuer of a bond (or money market instrument) may become unable or unwilling to pay interest or repay capital to the Fund. If this happens or the market perceives this may happen, the value of the bond will fall. High yielding (non-investment grade) bonds are more speculative and more sensitive to adverse changes in market conditions.
  • When interest rates rise (or fall), the prices of different securities will be affected differently. In particular, bond values generally fall when interest rates rise. This risk is generally greater the longer the maturity of a bond investment.
  • The Fund may use derivatives towards the aim of achieving its investment objective. This can result in 'leverage', which can magnify an investment outcome and gains or losses to the Fund may be greater than the cost of the derivative. Derivatives also introduce other risks, in particular, that a derivative counterparty may not meet its contractual obligations.
  • If the Fund holds assets in currencies other than the base currency of the Fund or you invest in a share/unit class of a different currency to the Fund (unless 'hedged'), the value of your investment may be impacted by changes in exchange rates.
  • When the Fund, or a hedged share/unit class, seeks to mitigate exchange rate movements of a currency relative to the base currency, the hedging strategy itself may create a positive or negative impact to the value of the Fund due to differences in short-term interest rates between the currencies.
  • Securities within the Fund could become hard to value or to sell at a desired time and price, especially in extreme market conditions when asset prices may be falling, increasing the risk of investment losses.
  • The Fund involves a high level of buying and selling activity and as such will incur a higher level of transaction costs than a fund that trades less frequently. These transaction costs are in addition to the Fund's Ongoing Charges.
  • The Fund may invest in contingent convertible bonds (CoCos), which can fall sharply in value if the financial strength of an issuer weakens and a predetermined trigger event causes the bonds to be converted into shares of the issuer or to be partly or wholly written off.
  • The Fund could lose money if a counterparty with which the Fund trades becomes unwilling or unable to meet its obligations, or as a result of failure or delay in operational processes or the failure of a third party provider.
  • SPACs are shell companies set up to acquire businesses. They are complex and often lack the transparency of established companies, and therefore present greater risks to investors.
Steve Cain

Steve Cain

Portfolio Manager


2 Jun 2020