A Strategy That Has Successfully Hedged Equity Exposure

March 15, 2016

by Robert Huebscher

Randy Swan is president and CEO of Swan Global Investments and its portfolio manager.

Randy developed the Defined Risk Strategy in 1997 to help protect clients from large losses. Before founding Swan Global Investments, Randy was a CPA and senior manager for KPMG’s Financial Services Group, primarily working with insurance companies and risk managers. His experience at KPMG helped him design the DRS, as he was able to see firsthand how insurance companies manage risk. The DRS seeks to use options strategically and tactically to structure particular risk/reward parameters in portfolio management.

Randy is a frequent speaker at industry conferences such as the Options Industry Council’s Wealth Summit and the Alternative Investment Summit, among others. Additionally, he serves on the Advisory Leadership Council of the Options Industry Council (OIC). The initiative is designed to support education within the financial advisor channel and is specifically focused on advancing the awareness and use of options in building a superior portfolio.

Randy is a 1990 graduate of the University of Texas with a master’s degree in professional accounting.

I spoke to Randy on March 7.

Some of our readers may not be familiar with you or your firm. What led you to start Swan Investments, and what is your core mission as an asset manager?

I started Swan Global Investments in 1997. It was based on the concept that the investment industry has tried to solve the risk problem through diversification and asset allocation. Modern Portfolio Theory says that if you combine different non-correlated assets, you end up with a diversified portfolio that lowers your risk.

I think there’s a fundamental flaw in that logic. When you go through periods of market distress like 2007-2009, asset correlation coefficients aren’t necessarily going to work the way you want. That proved to be true in that last bear market.

We believe that market risk cannot be solved by Modern Portfolio Theory and that diversification is only part of the solution. Using options to hedge your underlying equity exposure is a better, more direct way to manage market risk. Our philosophy as a firm is that market timing and stock selection are a difficult way to outperform the market over an entire investment cycle, which is defined as including both a bull and a bear market. Our mission as a firm is to apply the same hedging strategy to various underlying assets in which our different products are invested, whether it is the S&P 500, emerging markets, foreign developed markets, or small-cap stocks. We generally use ETFs to get this stock exposure and we are always invested and always hedged.

Your firm has been around since 1997, but you didn’t launch your first open-end fund until 2012. What products did you offer prior to 2012, and what led you to create your four mutual funds?

Prior to the launch of our four mutual funds, we offered the same strategy on a separately managed account (SMA) level, with the S&P 500 as the underlying asset. We also allowed individuals to access our strategy on multiple different assets, such as emerging markets, and as an overlay program. An overlay program is where someone comes to us with an existing portfolio, which could be low cost basis stocks or a concentrated position, and we are able to create a customized hedge and then apply our option hedging strategy on top of that.

Those vehicles have a relatively high minimum, for example $100,000 for our SMAs. To greatly expand the universe of investors who could benefit from our strategy, we decided to offer mutual funds with a much more modest minimum of $2,500.

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Equity Exposure

Equity Exposure