Insight post

Aug. 17, 2017

Defining Risk in Foreign Developed Markets

Defining Risk in Foreign Developed Markets

Let’s turn back the calendar a year and remember where we were in summer 2016.

Great Britain made the monumental decision to leave the European Union. Marine Le Pen was threatening to do the same in France, as well as abandon the Euro as a common currency. Markets were nervously watching Italian banks, wondering if another round of bailouts was pending. In the U.S., Donald Trump made opposition to free trade and international cooperation central themes of his candidacy.

How did the international stock markets respond?

Between June 30th of 2016 and 2017 international stocks were up over 20%.

The 20.83% gain of the MSCI EAFE was better than the 17.90% return on the S&P 500. Granted, some say a rebound in international markets was long overdue. Since the Financial Crisis of late 2007 to early 2009, the stock markets of developed, non-U.S. nations have lagged the S&P 500 by a wide margin. It was Europe’s turn to have a moment in the sun, but predicting it would have been difficult if one only paid attention to the negative headlines a year ago.

It is for this reason that Swan Global Investments unveiled its expanded line-up of investment solutions over the last few years. While the Defined Risk Strategy was originally applied to U.S. large cap stocks, the line-up now includes U.S. small cap stocksemerging markets, and foreign developed markets.

Is Diversification Keeping Its Promises?
Multiple Asset Classes

The promise of diversification has always been two-fold. First, different asset classes or styles will go in and out of favor, with different investments typically taking turns as “king of the mountain.” Swan believes that it is difficult, if not impossible, to consistently predict which asset class will have the best returns going forward. Lacking 20/20 foresight into the future, the next best option is to cover all your bases by diversifying into multiple asset classes.


Mitigating Risk

The second promise of diversification is to mitigate losses on the downside. Unfortunately, when markets sell off significantly, correlations tend to increase, and global markets tend to go down together. Traditionally, many international managers sought to mitigate downside risk by rotating in or out of different countries or regions.

The Problem with this Kind of Diversification

These two elements of diversification, however, require the kind of market-timing that Swan has always been against. The two reasons for this stance are illustrated in the table below:


Calendar Year Returns as of June 2017 - Defining Risk in Foreign Developed Markets - Swan Insights

Source: Zephyr StyleADVISOR, Swan Global Investments


The above table displays only four countries, plus emerging markets, but two key take-aways are readily apparent:

  • First of all, there doesn’t appear to be any rhyme or reason as to which countries or regions will be the worst-performing at any given time. With little reason, how do people time the markets effectively?

  • Second, during the worst years like 2000–2002 or 2008, we see markets moving down in lock-step. The high correlation among the markets during downturns means there is little to no risk protection.

The DRS and Foreign Developed Markets

This is why Swan Global Investments brought its philosophy of “always invested, always hedged” to both developed and emerging international markets. When in favor, global investing can boost the returns of a U.S.-centric portfolio. When markets sell off, the DRS investments are hedged to protect against major losses.

By adding international equities to Swan’s line-up, investors have access to a larger opportunity set. During those times when foreign developed markets are in favor (or foreign emerging markets or U.S. small cap, for that matter) investors can participate in their rallies. While the past year or so has been good for foreign markets, there is no guarantee that it will continue on indefinitely. Any of the aforementioned events or new, unforeseen crises could potentially turn the bull market in international equities into a bear. However, by applying the Defined Risk Strategy to foreign developed, emerging markets and U.S. small cap stocks we believe we have developed the building blocks to define risk in, and therefore redefine, the global portfolio.

About the Author:

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Marc Odo, CFA®, CAIA®, CIPM®, CFP®, Client Portfolio Manager, is responsible for helping clients and prospects gain a detailed understanding of Swan’s Defined Risk Strategy, including how it fits into an overall investment strategy. Formerly, Marc was the Director of Research for 11 years at Zephyr Associates.

Research from this Author
Important Notes and Disclosures:

Swan Global Investments, LLC is a SEC registered Investment Advisor that specializes in managing money using the proprietary Defined Risk Strategy (“DRS”). SEC registration does not denote any special training or qualification conferred by the SEC. Swan offers and manages the DRS for investors including individuals, institutions and other investment advisor firms. Any historical numbers, awards and recognitions presented are based on the performance of a (GIPS®) composite, Swan’s DRS Select Composite, which includes non-qualified discretionary accounts invested in since inception, July 1997, and are net of fees and expenses. Swan claims compliance with the Global Investment Performance Standards (GIPS®).


All Swan products utilize the Defined Risk Strategy (“DRS”), but may vary by asset class, regulatory offering type, etc. Accordingly, all Swan DRS product offerings will have different performance results due to offering differences and comparing results among the Swan products and composites may be of limited use. All data used herein; including the statistical information, verification and performance reports are available upon request.
The MSCI (Morgan Stanley Capital International) EAFE index comprises the MSCI country indexes capturing large and mid-cap equities across developed markets, excluding the U.S. and Canada. The MSCI(Morgan Stanley Capital International) Emerging Markets Index is designed to measure equity market performance in global emerging markets. Indexes are unmanaged and have no fees or expenses. An investment cannot be made directly in an index. Swan’s investments may consist of securities which vary significantly from those in the benchmark indexes listed above and performance calculation methods may not be entirely comparable. Accordingly, comparing results shown to those of such indexes may be of limited use. The adviser’s dependence on its DRS process and judgments about the attractiveness, value and potential appreciation of particular ETFs and options in which the adviser invests or writes may prove to be incorrect and may not produce the desired results. There is no guarantee any investment or the DRS will meet its objectives. All investments involve the risk of potential investment losses as well as the potential for investment gains. Prior performance is not a guarantee of future results and there can be no assurance, and investors should not assume, that future performance will be comparable to past performance. All investment strategies have the potential for profit or loss. Further information is available upon request by contacting the company directly at 970–382-8901 or www.www.swanglobalinvestments.com216-SGI-081717