At Swan Global Investments, we are frequently asked “In which category do you belong?” or “Who are your competitors?” We believe that the Defined Risk Strategy is a rather unique solution, and no one is currently doing what we are doing. The DRS doesn’t fit nicely into a predefined box.

That said, it is inevitable that the Defined Risk Strategy gets compared against other managed products. This post will be the first in a series where we compare and contrast the DRS against other types of investment strategies. Because we are most frequently compared to tactical asset allocation or market-timing strategies, this is where we will start.

The one and only thing that the DRS has in common with tactical asset allocators is an aversion to down markets. Passive strategies or stock-pickers who hew closely to a benchmark will track their benchmarks on both the upside and the downside. If the market has a major sell-off, stock pickers typically offer little downside protection, and passive strategies offer none. Both the Defined Risk Strategy and most tactical asset allocators attempt to actively minimize exposure to down markets.

Source: Zephyr StyleADVISOR

However, the manner in which tactical asset allocators (TAA) and the DRS attempts to accomplish this goal couldn’t be more different.

The typical tactical asset allocator’s value proposition is based upon market timing. A TAA strategy will typically make significant, top-down changes to their strategy’s asset allocation based upon changing forecasts on the marketplace or some sort of indicator based on past historical occurrences.

A simplified description of a tactical asset allocator’s philosophy might be, “The best way to not lose money is to avoid the asset classes with the worst performance.” Moreover, the opportunity set of a tactical asset allocation strategy is usually very broad. Unlike a large-cap stock picker that can only choose from a field of 500 or 1,000 stocks, the opportunity set for a TAA strategy is much broader.

In theory, this is a good way to minimize losses. As the table above illustrates, there can be wide dispersions between the best and worst performing asset classes. With a wide-open mandate, a tactical asset allocator could have many more asset classes to choose from.

However, the whole trick to being a successful tactical asset allocator is being in the right place at the right time. It’s just as easy to be caught out on the wrong side of the tracks. If a TAA gets their market calls wrong, the potential for underperformance is every bit as great as the potential for outperformance. The investment landscape is littered with TAA strategies whose “Midas Touch” eventually deserted them, leaving them well behind the market. I like to sum up the experience of TAA strategies as “live by the sword, die by the sword.”

Different Approaches to Downside and Upside

At Swan Global Investments we believe it is very difficult if not impossible to always be one step ahead of the market, as required by a market-timing strategy. It’s inevitable that any given TAA strategy will have some of their market timing calls work out in their favor and some will go against them, but we do not believe market-timing to be a sustainable long-term strategy.

Swan’s investment motto is “Always invested, always hedged.” We do not profess to know when markets will go up or go down. We remain always invested with a buy-and-hold position in a given market, in order to capture as much of the upside as we can. However, we never know when steep sell-offs might occur, so we always maintain a hedge to protect our assets against bear markets. We always maintain this hedged equity approach. I like to say it doesn’t matter if the markets are down 50% like they were during the Financial Crisis or if the market is in an eighth year of a bull market- the Defined Risk Strategy is always doing the same thing.