How To Use ETFs To Stay Invested Without Fearing The Bear – Investor's Business Daily

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Can the bull market keep running?

XAutoplay: On | OffThat’s one of the biggest questions on investors’ minds. No one can answer that with certainty — and Swan Global Investments doesn’t try to predict what could happen.

Instead, the Durango, Colo.-based asset management firm, which oversees more than $4.5 billion in assets, covers its bases by keeping clients invested and hedged at the same time.

“The second-longest bull market in U.S. history recently surpassed its 8 1/2-year birthday. Having enjoyed a remarkable run, many investors are wondering how much gas is left in the tank and how one might seek to protect their market gains,” Marc Odo, director of investment solutions at Swan Global Investments, told IBD. “Conversely, investors are also worried about leaving the party too soon and forgoing further gains. Investors face a tough balancing act.”


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That’s why Swan seeks to minimize potential downside risk with its Defined Risk Strategy (DRS). Its flagship Swan Defined Risk Fund (SDRAX) has underperformed the S&P 500 since its 2012 launch. But a comparable account Swan has run since 1997 has outpaced the benchmark index with an 8.5% vs. 7.2% return through June 30, according to data from Swan.

During the 2000-02 bear, DRS posted gains in each of those years. And in 2008, its 4.5% deficit was far narrower than the S&P 500’s 37% plunge.

Odo explains below, in his own words, how the strategy uses exchange traded funds and hedging to help clients stay in the markets without fearing the bear:

The truth is, no one knows how much longer the bull market might run. It might end tomorrow, or it might go on for years.  At Swan Global Investments, we don’t have a crystal ball to tell the future nor do we pretend to. Therefore, the prudent approach is to build a portfolio comprised of diversified asset classes that attempts to provide direct protection against major market sell-offs.

Swan Global Investments believes the best way to do this is to be “always invested, always hedged.” Our unique Defined Risk Strategy (DRS) is applied to a number of mutual funds that exposes investors to a given asset class and helps protect on the downside via intelligent and cost-efficient hedging. This hedging attempts to provide the direct protection investors need in this aging bull market if they want to continue participating in it.

Our flagship offering, Swan Defined Risk Fund, invests in the U.S. large-cap market by equally weighting the Select Sector SPDRs. The equal weight sector approach gives us a more conservative, contrarian, value-tilt. In addition, we hedge our market exposure by buying put options on the S&P 500. These put options give us the right to sell the S&P 500 at predefined price levels should the markets go south. Being able to sell at prices higher than the current market level lets us offset losses in other parts of the portfolio. The Defined Risk Strategy willingly sacrifices some upside potential in order to seek downside protection.

If one looked at the headlines coming out of Europe last summer, few would have predicted the large run-up developed international markets have enjoyed over the last year or so. With Brexit, Marine Le Pen, and the Italian banking system on everyone’s mind, the fact that iShares MSCI EAFE (EFA) has rallied since the Brexit vote on June 23, 2016, has caught many people by surprise. In a separate offering, Swan invests in EFA for exposure to the growth potential of foreign developed markets and seeks to protect on the downside by investing in put options on the same ETF.

In emerging markets, the roller-coaster ride that can either thrill or terrify investors goes on. After a rough couple of years, emerging markets are on the ascent in 2017. However, one doesn’t have to look back too far for a time when investors were fleeing emerging markets. It’s this feast-or-famine nature of the asset class that often scares investors away. For those looking for a potentially less volatile play on emerging markets, Swan does have a product focused on emerging market. Swan seeks to change the emerging market dynamic by investing in ETFs like iShares MSCI Emerging Markets (EEM) and then hedge its exposure. Some emerging markets strategies only hedge the currency exposure, but Swan takes it a step further and hedges its overall market exposure by buying put options on EEM.

The overall impact of the Defined Risk Strategy is to produce a tighter, more predictable, less volatile, and frankly, more boring range of outcomes on a given asset class. Swan believes that the potential for bear markets is always present and that most investors can’t afford another major sell-off to their portfolio like they experienced in the dot-com bust of 2000-02 or the financial crisis of 2007-09. On the flip side, the opportunity cost of staying on the sidelines in cash is also quite high, especially given the fact that yields on cash have essentially been zero over the last nine years. In our opinion, one should remain invested, but actively protect their portfolio against major losses.

Always invested, always hedged — that’s our motto.

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