David Pinsen, the founder of Portfolio Armor, discusses the The Hedged Portfolio Method.
Q1 2020 hedge fund letters, conferences and more
Table of Contents
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What Is A Hedge
- A hedge is something that always goes up in value when an underlying security goes down in value significantly.
- If you want to hedge stocks, other asset classes such as gold, or bonds are not hedges.
Black Swans: Why Hedge Individual Stocks
- JP Morgan Study: 40% of Russell 3000 stocks suffered catastrophic losses between 1980 and 2014.
- "Catastrophic loss" defined as a decline of 70% without recovering.
- 57% of information technology stocks experienced catastrophic declines during this period.
- Black swan examples: 2008 Financial Crisis, 2020 COVID-19 (e.g., cruise ships, REITs), antitrust action.
Black Rain: Hedging Portfolio And Market Risk
September 18th, 1989.
Black Rain
The Most Effective Hedge: Put Options
- Protection even if the underlying security goes to zero.
- Non-linearity means a little goes a long way, so less drag on returns.
Minimizing The Cost Of Hedging
- Decide how much you're willing to risk
- Look at OTM puts
- What's your max drawdown including hedging cost?
- Compare annualized cost as a % of position value
- (SPY $310..62 on Monday)
Minimizing Cost With Collars
- Giving up potential upside to reduce the cost of hedging.
How Much Should You Pay To Hedge?
- How much are you up on a position you can't sell?
- For other positions, is the cost of hedging greater than your expected return?
Starting From Scratch: The Hedged Portfolio Method
- Start with universe of hedgeable securities.
- Estimate potential returns for them.
- Calculate their hedging costs.
- Subtract hedging cost from potential returns.
- Sort by potential return net of hedging cost.
- Buy and hedge a handful of the names at the top of the list.
Top Names Performance, Unhedged
- Have outperformed SPY by 0.62% so far.
- Working to increase outperformance.
Hedged Portfolio Example, 12/26/2019
Performance Of That Hedged Portfolio
Putting Together A Hedged Portfolio
- Our hedging tool scans for optimal hedges.
- Our hedged portfolio construction tool creates portfolios following the hedged portfolio method, designed to maximize your returns while strictly limiting risk.
- Website: PortfolioArmor.com
- Coupon code for Portfolio Armor website: SFAAII.
