Looking in the Rearview Mirror: Risk Mitigation and the Presidential Election
In a previous post, we presented several risk mitigation strategies with the potential to help bolster and defend portfolio performance by hedging against market moving events. The following synopsis takes a look in the rearview mirror at how risk mitigation strategies fared post-election. And with potentially no shortage of volatility-inducing events in the future (e.g., Brexit, January Senate election, stimulus debate), this information could be vital.
Seeking to achieve financial goals
Typically, the goal of most investors comes down to protecting invested capital and earning attractive risk-adjusted returns. As we have witnessed over the years, market crises can derail that goal –sometimes dramatically. A 50% drawdown implies the need to earn 100% just to come out even. Drawdowns may occur more often than many investors think. On average there has been a major drawdown nearly every two to three years.
Crises don’t present the same challenges
There are a variety of risk mitigation strategies available in the market, including puts, managed futures, Treasurys and alternative risk premia (ARP). In our view, demand for a variety of alternatives persists because each crisis may present a different hedging challenge. Consider the asset class performance during each of the 12 crises shown in the chart below. It’s no wonder that risk mitigation isn’t a one-size-fits-all endeavor.
In our view, if crises do not look alike, neither should a portfolio hedging strategy.
The 2020 election provided another set of characteristics that influenced hedging outcomes. Prior to the November election, market participants appeared to be bracing for a “blue wave” and the potentially negative implications for risk assets (higher inflation and rates). We saw indications of this in the VIX.1 Even though it averaged 17.52 for the five years ending November 5, 2020, and averaged just over 28 for the past six months, it shot up to about 40 days before the election. This market sentiment contributed to excessive demand for risk mitigation hedges.
With this backdrop, it is understandable that implementing a hedging a strategy in the days before the election came at a steep price. Was it worth it?