The leading lights of Wall Street agree that the
World is a lot more dangerous than it was 10, 20 or 30 years ago, when
investors worried more about return on their capital rather than return of it
(Barron’s Roundtable, 1-16-12). In
summary, the Roundtable panelists highlight why the market is different now
than it was:
- Low return/high
risk: last year the S&P 500
ended exactly where it started the year.
Within the year, however, there was huge volatility which is
hurtful to individual investors.
Leveraged ETF’s which delivers 2 or 3 times the market’s return
could be to blame for the huge upswings and downswings at the end of the
day, as they need to rebalance their positions by buying or selling more
stock before the close
- Elimination of the uptick rule; enabling short
sellers to drive prices lower
- High leverage due to zero interest rate policy
- Potential for oil supply disruption
- Interventionist Government policies
On one hand, large cap dividend growing stocks have
seldom been more attractive. On the
other hand, investors are frozen by the FUD factor (fear, uncertainty and
doubt) caused by high volatility. What
to do?
At Stafford, we have worked with an alternative
investment manager who has developed the Arcas Covered strategy. The Arcas Covered strategy is negatively
correlated to the general stock market.
The strategy will deliver high returns in down markets and still provide
a positive return over a normal market cycle.
It will reduce the market risk in a portfolio as well as provide
significant “fat-tail” protection for the low probability, high impact event,
such as the Lehman bankruptcy, that investors are concerned about.
The strategy involves shorting the S&P 500 index
and writing out of the money puts that expire each quarter. Both margin and option approval is required.
As you know, it is extremely difficult to find a
hedging strategy that will provide a positive rate of return over a multi-year
market cycle and strong returns during a bear market. (Most short sellers cannot deliver positive net returns over a
market cycle so they become a timing bet, not a core portfolio holding). Bonds and cash did that very well from
2000-2011 and is why investors have become over allocated to bonds and
cash. As a result, we believe most
investors are under-allocated to equities.
By effectively hedging out market risk and fat tail risk, the Arcas
Covered strategy will allow investors to increase their equity allocation
without taking on significantly more risk and volatility.
The proportion of a portfolio allocated to this
strategy is an individual matter and should be discussed with us. This is a strategy to lower portfolio risk
and should enhance income. The
principal risk is if the market should rise by more than 5% in a quarter, this
portion of a portfolio will decline.
