Should Your Portfolio Protection Work Fast or Slow?
Should Your Portfolio Protection Work Fast or Slow?

Should Your Portfolio Protection Work Fast or Slow?

Should Your Portfolio Protection Work Fast or Slow?

We have often argued that investments that perform well in protracted market drawdowns may be more valuable than ones that perform better during sharp crashes. (PageĀ 1)

In contrast, trend-following strategies have generally posted very strong returns (consistent with what weā€™ve documented in previous market drawdowns and crises) (PageĀ 1)

For example, in the short-lived drawdown of March 2020, many options based strategies produced exceptional gains, while trend-following was generally flat. Bonds also provided offsetting returns that time, as portfolio pain was really driven by equites. (PageĀ 3)

Options-based hedging strategies, while showing positive returns in some cases, have been disappointing in the magnitude of their contributions (PageĀ 3)

Most importantly, drawdowns like the current one, in which adverse conditions impact public and private investment strategies in a persistent way, are the most damaging to investor portfoliosā€”so they should matter the most when identifying strategies intended to improve a portfolioā€™s resilience. (PageĀ 3)

In this article we argue that of these two kinds of strategies, the tortoise (i.e., trend-following) is more valuable than the hare (i.e., options based and tail-risk funds) for most investors. (PageĀ 5)

More pointedly, portfolio protection strategies that work best over shorter-term ā€œtailsā€ are not as valuable as strategies that can deliver over longer ones. (PageĀ 5)

(left side) but are less impressive in longer ones (right). Trend-following shows roughly the opposite pattern: posting its most impressive returns in the protracted bad times options-based hedging strategies outperform in shorter drawdowns (PageĀ 5)

Regardless of investor preferences, the evidence suggests a clear trade-off between short-term crash protection and long-term returns. (PageĀ 7)

Trend-following strategies arenā€™t new, but are likely to see renewed interest on the heels of recent strong performance. So what should investors look for when comparing strategies? (PageĀ 8)

Papers on tail risk tend to come out after markets lose money, leaving investors with the unappealing prospect of buying insurance after it was actually needed. (PageĀ 9)

which shows tumultuous times tends to be sticky at annual horizons) Macro uncertainty tends to be persistent, suggesting the turmoil weā€™ve seen so far this year is unlikely to go away any time soon (see Panel A of Exhibit 5, (PageĀ 10)