Strategy guide: Global risk mitigation

Objective

Our Global Risk Mitigation (GRM) strategy aims to provide clients with an efficient hedge to reduce equity risk by bringing together a variety of hedging strategies into one solution.

This is a defensive strategy that aims to deliver a downside beta to equities of -0.2 or lower. This means that if we shock the equity market down by 10%, we expect the GRM strategy to deliver a minimum positive return of 2%.

Our GRM strategy also aims to offer greater protection as the equity market shortfall increases (known as convexity). This means that the greater the fall in the equity market, the stronger the potential positive return generated by the strategy.

This strategy contains around 30 systematic derivative strategies. We actively manage these in an effort to deliver the below objectives.

Figure 1: GRM objectives

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Key facts

  • GRM is an index – ENHAGRM1 on Bloomberg.
  • The index contains around 30 actively managed derivative strategies, targeting a beta to global equities below -0.2
  • The strategy has daily liquidity and no performance fee
  • GRM is convex – GRM is designed so that as markets fall, the positive return of the strategy should increase
  • GRM aims to reduce portfolio drawdowns and increase long-term compounded investment returns and information ratios
  • Our GRM strategy can be accessed as a derivative overlay to an equity portfolio
  • A three-times levered version of GRM (ENHAGRM3) is also available in a standalone fund format

The portfolio problem

Historical protection strategies have drawbacks. If equities are a primary route for delivering your return objective, what tools have previously been available to help limit losses in extreme events?

Table 1: Pros and cons of different protection strategies

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Strategy aims

GRM is an efficient hedging solution for investors with exposure to developed market equities. We designed it to be a defensive strategy. It allows investors to increase allocations to higher expected return investments, while still managing their overall drawdown risk. It aims to tackle the fundamental problem of investors having large parts of their portfolios tied-up in assets that offer little return potential, but that still carry significant interest-rate risk and inflation risk.

The strategy also seeks to address path dependency in portfolio hedging, to deliver more consistent outcomes across different types of bear markets. It brings together a range of different strategies into one managed index.

GRM targets a strong negative correlation to equities. This gives investors the predictability they need to construct robust portfolios.

We designed the strategy to limit the cost of hedging in periods of rising/flat equity markets. This makes it easier for investors to maintain exposure in more benign environments.

Allocating to such a strategy in a regular manner can help reduce portfolio drawdowns (the market’s decline from its peak). In doing so, it improves the overall compound rates of return on a portfolio over time.

The strategy aims to reduce the losses incurred by a portfolio of developed market equities during a major sell-off. It aims to reduce the loss by at least 25% and by 75% for our GRM strategy that is three-times levered.

Portfolio construction

Our GRM strategy consists of four building blocks:

  1. First-risk strategies: Strategies that deliver a windfall gain in the event of a market shock and perform strongly in the initial phase of a crisis.
  2. Tail-risk strategies: Long volatility and tactical strategies that benefit from sustained increases in volatility.
  3. Systematic trends: Strategies that seek to capture trending market behavior (positive or negative) across multiple asset classes and markets.
  4. Defensive factors: Strategies that have a positive expected return over the medium-to-long term. They exhibit a low correlation to equities, particularly during periods of equity market stress.

We combine these through a portfolio construction process that enables the team to adjust the portfolio in response to market conditions. Each category plays a distinct role in the portfolio at different points in the equity market cycle.

There is no single hedging strategy that will protect portfolios through the entirety of a sell-off. But by actively managing a diversified set of defensive strategies throughout a market sell-off, we can help protect your portfolio. By allocating across strategies, depending on their cost and value at a particular time, this can also help to reduce the cost of that protection.

Figure 2: Returns for an equity portfolio and preferred environment for each risk mitigation building block

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Source: abrdn & Bloomberg, August 31, 2022. PAST PERFORMANCE IS NOT A GUIDE TO FUTURE RESULTS.

Key features

We actively manage our GRM strategy. We allocate across multiple hedging strategies in an effort to best protect investors at all times.

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Key benefits

  1. Compounding

    Why is protecting your portfolios from drawdowns so important? Long-term investors may try to ride out volatility by investing in the stock market. After all, equities typically have the highest expected returns.

    But the real benefit of this strategy comes from mitigating drawdowns, which can have a resounding impact on compounded returns. Adding the strategy as an overlay to an equity portfolio can help to reduce drawdowns, improve risk-adjusted returns and deliver stronger long-term compounded returns than a pure-equity portfolio.

    For example, if you invest $100 dollars and there is a 50% fall in the market, that leaves you with $50. To make that $50 back into $100, your portfolio has to double in value – meaning 100% of return. But by combining your equity exposure with the GRM strategy (100% overlay) – and assuming, conservatively, that GRM delivers a return of around 20% – the market value of your portfolio will go down to $70. As a result, you would need a return of 42% to get back to your initial value. Importantly, GRM seeks to reduce both the loss and the subsequent time to recovery.

  2. Tail-risk protection

    GRM is designed to add a level of protection to your portfolio in extreme events. It isn’t required the majority of the time, but the objective is that the benefits become apparent when something bad happens. We all know the timing of a correction/tail event is very difficult to predict, so the exposure needs to be held as a core allocation.

    To ensure that you have the protection on at the time it’s needed, the “cost of ownership” (i.e., the negative carry) needs to be low.

  3. Convexity

    Our GRM strategy targets exponential pay-offs in the event of a significant decline in equity markets, while minimizing the cost of carry under normal conditions. This allows investors to maintain exposure to the GRM alongside their equity holdings. This position keeps risk under control, with the aim of improving the overall expected return of the portfolio.

The bottom line is that our GRM strategy has been designed to address the single biggest problem investors face today: finding alternatives to fixed income in order to manage risk in a portfolio.

IMPORTANT INFORMATION

Past performance is no guarantee of future results.

Indexes are unmanaged and have been provided for comparison purposes only. No fees or expenses are reflected. You cannot invest directly in an index.

The use of leverage will also increase market exposure and magnify risk.

Derivatives are speculative and may hurt the Fund’s performance. They present the risk of disproportionately increased losses and/or reduced gains when the financial asset or measure to which the derivative is linked changes in unexpected ways.

Alternative investments involve specific risks that may be greater than those associated with traditional investments; are not suitable for all clients; and intended for experienced and sophisticated investors who meet specific suitability requirements and are willing to bear the high economic risks of the investment. Investments of this type may engage in speculative investment practices; carry additional risk of loss, including possibility ofpartial or total loss of invested capital, due to the nature and volatility of the underlying investments; and are generally considered to be illiquid due to restrictive repurchase procedures. These investments may also involve different regulatory and reporting requirements, complex tax structures, and delays in distributing important tax information.

Hedge funds use sophisticated investment strategies that may increase investment risk in your portfolio. Among the risks presented by hedge fund investments are: the use of unregistered investments, which may make it difficult to assess the performance of the holding; risky investment strategies, which may result in significant losses; illiquid investments that may be subject to restrictions on transferability and resale; and adverse tax consequences.

US-020922-180089-1

RISK WARNING

The value of investments, and the income from them, can go down as well as up and you may get back less than the amount invested.