Benchmarking the Swan Defined Risk Strategy

Setting an Appropriate Benchmark

The Defined Risk Strategy (DRS) is distinct—traditional investment classifications don’t fit and standard indices are not ideal benchmarks.

 

Our hedge equity approach creates a new risk/return profile for the portfolio that is different than a long-only equity investment. As such, our returns over market cycles are not closely correlated with the underlying equity investment.

 

So what is the most appropriate benchmark?

What’s Your Target: Short-Term Returns or Long-Term Results?

It seems regardless of the audience or investment acumen, recency bias and focus on short-term returns drive many decisions. After all, short relative performance versus a benchmark is a primary factor in many investment and manager selections.

 

We believe the key to reaching long-term objectives, sustaining giving power, or maintaining funded status is to generate consistent returns through full market cycles.

Our Target Return Band is Our Benchmark

We believe the best way to evaluate Swan DRS performance is through the prism of the Target Return Band.

 

In any given year, it is our goal that returns of the DRS will be within or above the blue shaded area. In 19 of 22 years, they have been.

 

This benchmark shows historic year-by-year performance and provides a target for future performance for any DRS solution (asset class) relative to a wide spectrum of annual return possibilities for the respective underlying equity investment.

Source: Source: Swan Global Investments and Morningstar; the S&P 500 Index is an unmanaged index and cannot be invested into directly. Swan DRS returns are from the Select Composite, net of all fees. NOTE – this chart is for illustration purposes, not a guarantee of future performance. The charts and graphs contained herein should not serve as the sole determining factor for making investment decisions.

Anatomy of the Target Return Band

The graph above shows the risk/return profile of the Swan Defined Risk Strategy and it’s three portfolio components:

The Red Line: Long Equity Position

Represents the risk/return profile of our passive underlying equity investment.

The Gold Line: Hedged Equity Position

Shows the redefined risk/return profile created by hedging an underlying equity position with a long-date put option(LEAP).

The Blue-shaded Region: Options Premium Collection Trades

Shows the historical performance of our option premium collection trades, added to hedged equity position.

The risk in equity investing is defined by the put option. The gold line flattens out on the left (loss) side of the graph as market losses worsen yet remains upward-sloping on the right (gains) as the market continues to gain.

The Target Return band (blue-shaded band) is simply created by adding a historical range of returns of the option premium component to the hedged equity position. The top edge of the blue band is defined by the average returns, while the bottom edge of this blue band is defined by the worst historical return of the option premium component. We believe this is a more conservative way of anticipating the DRS’s overall returns.

A Benchmark Aligned with Institutional Investment Objectives

Intuitional investors have long-term, even perpetual investment objectives, that we believe aligns with the goals of the DRS: producing stable, consistent results over market cycles.

 

As the Defined Risk Strategy is a unique approach to shifting the risk/return dynamic in equity investing, a single index or even blend of indices may not serve as an appropriate benchmark.

 

By providing historical annual returns and a target for future return expectations, we believethe Target Return Band serves as the best benchmark for measuring the performance of any DRS solution relative to its goals.

Yet our return patterns may not correlate with the S&P 500,or even the traditional 60/40 portfolio.