Please note , this post is not a solution, it is mere a discussion on the available options and risks
After reading a lot of literature on risk and hedging , I can distill the whole essence of risk management into a single sentence for Individual portfolios.
Holy Grail of hedging :
Find a strategy that performs strongly during crises yet doesn’t lose too much over a market cycle . This strategy/asset can have a material impact on portfolio performance over the long term
Objectives of a good Hedging Strategy for a Retail Portfolio : 1. Easy to Implement 2. Not based on forecasting / timing markets 3. Adding the strategy should not materially impact future returns or underperform a benchmark
Introduction: Most active investing strategies are short volatility in one way or another. Whether you buy equities, take long positions in risky bonds or engage in spread trades, you will tend to perform better in flat to rising markets than highly volatile ones. So the first question to ask for any active strategy is to check whether it is short volatility or long volatility. For most traditional investor portfolios adding a shorty volatility strategy should be carefully measured against it’s expected risk adjusted return
Assets which can be combined in an equity heavy portfolios for Risk Management
Here I am listing various assets which can be combined with an equity portfolio to reduce portfolio risk . However on a deeper analysis none of them meet the holy grail criteria and are prone to various idiosyncratic risks which are listed here
Option 1:**Long term treasury bonds** Risks: * Increase in Interest Rates * Black Swan Event where USD looses it’s monopoly as Global Reserve Currency * Global Defacto Strategy can result in rather unintended results when it matters with rebalances occurring in all portfolios in a similar timeframe
Option 2: VIXM or VIXY Risks * Looses a lot during regular market cycle with drawdowns up to 90% * Timing is important and difficult to implement as a holding strategy * Explosive returns do not compensate of the losses during the regular market cycle which result on timing luck
Option 3: Gold Risks * Does loose during raising interest rates * Experiences material drawdowns if not timed with a Trend . * Does not provide explosive returns in crisis
Option 4: Low Hanging Fruit: Combination of above 3 assets A combination of above assets , does help to certain extent which I am implementing in my portfolio , but the costs of benchmark underperformance loom large and drawdowns are not truly contained across various simulations . It is similar in philosophy to Ray Dalios All Weather , but I am not happy with the returns without leverage and unhappy with the risk induced by leverage
Option 5 : Timing Volatility through Option Strategies [Holy Grail?] This seems to be the sour grapes . I assume this is where the true skill reflects and helps funds to generate material alpha with leverage by protecting the downside.
Some known strategies on literature which are difficult to backtest
a. Rolling down OTM options
b. Timing Options based on volatility
c. VIX Calls [Similar to VXTH]
What are your views and strategies used in personal portfolios?
Quest for Holy Grail of Hedging in Retail Portfolios!
Please note , this post is not a solution, it is mere a discussion on the available options and risks
After reading a lot of literature on risk and hedging , I can distill the whole essence of risk management into a single sentence for Individual portfolios.
Holy Grail of hedging :
Find a strategy that performs strongly during crises yet doesn’t lose too much over a market cycle . This strategy/asset can have a material impact on portfolio performance over the long term
Objectives of a good Hedging Strategy for a Retail Portfolio :
1. Easy to Implement
2. Not based on forecasting / timing markets
3. Adding the strategy should not materially impact future returns or underperform a benchmark
Introduction:
Most active investing strategies are short volatility in one way or another. Whether you buy equities, take long positions in risky bonds or engage in spread trades, you will tend to perform better in flat to rising markets than highly volatile ones. So the first question to ask for any active strategy is to check whether it is short volatility or long volatility. For most traditional investor portfolios adding a shorty volatility strategy should be carefully measured against it’s expected risk adjusted return
Assets which can be combined in an equity heavy portfolios for Risk Management
Here I am listing various assets which can be combined with an equity portfolio to reduce portfolio risk . However on a deeper analysis none of them meet the holy grail criteria and are prone to various idiosyncratic risks which are listed here
Option 1:**Long term treasury bonds**
Risks:
* Increase in Interest Rates
* Black Swan Event where USD looses it’s monopoly as Global Reserve Currency
* Global Defacto Strategy can result in rather unintended results when it matters with rebalances occurring in all portfolios in a similar timeframe
Option 2: VIXM or VIXY
Risks
* Looses a lot during regular market cycle with drawdowns up to 90%
* Timing is important and difficult to implement as a holding strategy
* Explosive returns do not compensate of the losses during the regular market cycle which result on timing luck
Option 3: Gold
Risks
* Does loose during raising interest rates
* Experiences material drawdowns if not timed with a Trend .
* Does not provide explosive returns in crisis
Option 4: Low Hanging Fruit: Combination of above 3 assets
A combination of above assets , does help to certain extent which I am implementing in my portfolio , but the costs of benchmark underperformance loom large and drawdowns are not truly contained across various simulations . It is similar in philosophy to Ray Dalios All Weather , but I am not happy with the returns without leverage and unhappy with the risk induced by leverage
Option 5 : Timing Volatility through Option Strategies [Holy Grail?]
This seems to be the sour grapes . I assume this is where the true skill reflects and helps funds to generate material alpha with leverage by protecting the downside.
Some known strategies on literature which are difficult to backtest
a. Rolling down OTM options
b. Timing Options based on volatility
c. VIX Calls [Similar to VXTH]
What are your views and strategies used in personal portfolios?