SERVING UNIQUELY SUCCESSFUL FAMILIES
The Myth of Hedging the Downside in a Portfolio

The Myth of Hedging the Downside in a Portfolio

Drawing back the curtain of illusion

As hard as it is to believe, we are in the 9th year of a Bull market for U.S. stocks. From 3/9/2009 until today (9/5/18), the S&P 500 is up almost 400%. Although we’ve participated healthily in the equity run-up, many clients and constituents have voiced some concerns:

“We haven’t experienced a recession in almost a decade...one is coming for sure.”

“What do we do now? Shouldn’t we take some of our profits off the table?”

“Institutions and hedge funds often use various strategies to help limit their downside risk. Shouldn’t we do the same?”

“I’m getting closer to retirement and can’t afford to lose ½ of my portfolio.”

 In order to address these concerns, let’s document some FACTS:

During the current Bull Market run from March 2009 until today (9/5/18), the S&P 500 has experienced 5 “corrections” defined as a drop of greater than 10%, but less than 20% (Heck, the most recent one was in January 2018).

Since the end of World War II, there have been 11 “Bear Markets” defined as a drop of greater than 20% in the S&P 500.

Since the end of World War II, the longest “Bear Market” lasted a little less than 3 years (1999-2002).

In any given year, retired families with a sound financial plan do not spend 100% of their assets. As silly as it sounds, this is often the perception of new retirees “losing” ½ of their assets. The reality is, in our experience, retirees with a sound financial plan will spend 3-6% of their assets each year of retirement.

We do, in fact, “know” that another recession and/or Bear Market is coming. HOWEVER, we do not know when…….

Of course, while past performance in guarantee of future results, EVERY SINGLE TIME SINCE THE DAWN OF MAN, THE S&P 500 HAS RECOVERED FROM EVERY SINGLE “CORRECTION” AND “BEAR MARKET” AND HAS GONE ON TO SET NEW ALL-TIME HIGHS.

As Thomas Jefferson once famously wrote, “We hold these truths to be self-evident”. Why, then, don’t we do something about it to limit or avoid this downside volatility? Can’t we “hedge” it away? This short answer is….possibly. For decades, institutional investment managers and many hedge funds have come up with numerous strategies designed to limit short-term downside volatility. However, for any of these strategies to work consistently, two elements MUST match up:

the proper "hedging" strategy

the proper time period

Due to the inherent uncertainty of the equity markets, getting both of these right on a consistent basis rarely happens.

If you don’t believe us, simply ask Warren Buffet. He was so convinced of the illusion of the almighty hedge that he bet hedge fund managers $1 million dollars that a collective group of their hedge funds could not and would not surpass the return of the S&P 500 index over a decade. Well…in case you didn’t hear (spoiler alert), Warren Buffet was right. The hedge fund returns fell woefully short of that of the unmanaged S&P 500 Index. The costs and inefficiencies quite often don’t pay off. They may help dampen or mitigate short-term emotional pain, but often result in the erosion of long-term investment returns.

The costs and inefficiencies of hedging strategies quite often don’t pay off. They may help dampen or mitigate short-term emotional pain, but often result in the erosion of long-term investment returns.

At Dashboard, although we don’t employ the same tactics that hedge fund managers utilize, we are still vigilant and focused on overall portfolio volatility. After all, it is paramount to believe in and stick with an overall investment strategy – otherwise, the benefits of long-term growth can be lost.

We believe our planning and investment process includes 3 distinct types of beneficial hedges:

The next time portfolio volatility gets you rattled, take a minute and separate fact from fiction. Cast the emotional elements aside and consider the items discussed above. Realize that our goal is to achieve the best possible outcome given our desired level of risk over a meaningful period of time. If it were easily accomplished, or if there was no short-term downside, the upside wouldn’t be as nearly as rewarding!