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Dialing Back the Downside

By Timothy (Ty) Hogan
Wealth Management
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  • After record-breaking volatility in the first half of 2020, the options market is predicting that volatility remains above average going into 2021.    
  • The most severe recession since the 1930s has led investors to make extreme shifts in their portfolio, but it’s important for investors to understand the long-term implications.
  • Investment advisors are faced with a different challenge, build portfolios that allow their clients to remain invested despite elevated volatility.
  • At Fort Washington Investment Advisors, Inc. we believe that we have the unique expertise required to offer our clients investment solutions designed for today’s uncertainty.  

The "New Normal" for Market Corrections

A common phrase that has found its way into our daily lexicon is “the new normal.” As the chart below demonstrates, the new normal has been characterized by deeper and faster market corrections.
 
Recent Market CorrectionsIs the record-breaking volatility in 2020 an anomaly or is it here to stay? Time will tell but certain market evolutions such as high frequency data, machine learning, and no-fee trading may be contributing to a “new normal” for market volatility.
 

Demand for a Smoother Ride

In these unusual times, inherent risk seems to be waiting around every corner. It’s natural that investors are seeking new ideas to protect their portfolios. Changing a portfolio’s asset allocation is the simplest solution, but before you adopt the motto “cash is king” or start buying bullion, remember the old adage that “you can't have your cake and eat it too.”  
 
If your portfolio was designed to deliver a specific return based on achieving your future goals (i.e. fund retirement, pay for a child’s education, make a charitable contribution, etc.) then adjusting to a more conservative allocation may make achieving those goals unrealistic.  
 
Risk or return. Something has to give or you need an alternative solution to help bridge the gap between the risk-return tradeoff.
 

10 year historic allocation

As we adjust to life’s milestones, or the predictable events that change our willingness to take risk, our portfolio’s asset allocation may change automatically along a predetermined glide path. The current times are anything but predictable, however. As a result, many individual investors may have been tempted to accelerate that glide path and make the transition from a balanced allocation to a more conservative asset allocation earlier than expected.  Or, to take more drastic action and try to aggressively time the markets by moving to cash.      
 
Rather than letting the coronavirus be the catalyst to change your portfolio, consider other options. There may be solutions that allow you to remain invested in your desired asset allocation, an allocation designed to achieve your goals, while not letting “the tail wag the dog” by letting today’s volatility dictate your future.  
 

A Focus on Solutions

Over the past 30+ years Fort Washington’s heritage has been that of stewards for the assets of a life insurance company. Today, we continue to manage the assets of our parent company, Western & Southern Financial Group, as well as all of its insurance subsidiaries and numerous unaffiliated life and property & casualty insurance companies.  As Greater Cincinnati’s largest asset manager1,  managing $64.8 billion2 in assets its uncertain times like these that we believe our ability to manage risk sets us apart.
 
After the first half of 2020 a natural reaction is to reexamine your risk tolerance. Market volatility, persistently low interest rates, and the economic impact of the pandemic are all out of your control, but they’re controlling your portfolio. Even now as the global economy slowly starts to recover, it’s easy to understand why investors are focused on the short-term economic challenges and the policy uncertainty looming in November.    
 

If your goal is to stay invested but protect your downside, here are 3 potential solutions:

1. Hedged Equity Strategies

What is a hedged equity strategy?  
 
Hedged Equity Strategies are outcome-based portfolios that look to deliver a more conservative risk/return profile than the S&P 500. Managers vary in how they pursue that objective but their goal is the same: asymmetric returns. “Asymmetric returns” is a way of saying that you get more of the market upside and less of the downside. The goal of a hedged equity fund is to allow you to continue to participate in equity market gains while mitigating risk in declining markets.
 
Evaluating an investment manager is a complex and detailed process. In order to deliver best-in-class strategies to your portfolio, we are committed to necessary due diligence that is required in today’s complex investment landscape. We apply resources that include proprietary quantitative modeling, qualitative analysis, and manager interviews to select investment options that we believe will empower our clients. As noted below, strategies that strive to provide a more predictable outcome and smoother ride for equity investors.  

Hedged Equity Example

2. Innovator Exchange Traded Funds (ETFs)

What are Innovator ETFs?
 
Innovator Defined Outcome ETFs are the first group of liquid investment funds that trade on stock exchanges and help reduce an investor’s guesswork by structuring potential outcomes. The ETFs seek to offer limited upside equity exposure while also providing features that can protect investors when markets drop. The protection feature is called a “buffer.” The buffer is designed to decrease downside exposure to an underlying index once it reaches a certain point. 
 
These ETFs can be held indefinitely, providing defined outcomes on a point-to-point basis and resetting annually. For the investor focused on structured investment solutions and willing to sacrifice a portion of the upside for more certainty on the downside, Innovator ETF may be the right addition to you portfolio.  
 

3. Professionally Managed Option Strategies

How could options help my portfolio?
 
Options are notoriously associated with risk. With strategy names like iron condor, bear put spreads, and seagull options, it’s understandable why investors commonly have misconceptions on how options can actually be used to minimize risk. Options can be used to change your portfolio risk-reward profile by limiting your downside, enhancing yield, or reducing/exiting a position when the shares hit a target price.    
 
Certain option strategies can be thought of like insurance, allowing you to purchase protection if the market declines. Other strategies can offer a protective downside hedge at no cost. For example, if your goal is to maintain S&P 500 exposure but limit losses in the event of another crash, a “collar” strategy, noted below, offers you the ability to limit losses while capping some upside return. If you’re concerned about a particular event that may move the market or want to target achieving a certain return, the strategy can be customized for a predetermined time or specific price.
 
Illustrative Collar SchematicIf you’re not an expert in the field, the challenges of investing with options cannot be overstated. If used incorrectly, the risks to your portfolio can be catastrophic. Several investment advisors lack the expertise and risk management capabilities to offer these strategies to their clients.  
 
Now more than ever investment advisors are tasked with delivering worth to their clients. If the first half of 2020 is any indication of “the new normal”, investors deserve a manager than can deliver risk-based solutions customized to your needs and goals. At Fort Washington we believe that we have the unique expertise to allow you to stay the course towards achieving your goals while dialing back your downside.  

 


1 Cincinnati Business Courier 2019-2020 Book of Lists; ranked by locally managed assets as of June 2019.
2 Includes assets under management as of 6/30/2020 by Fort Washington Investment Advisors, Inc. of $60.9 billion and $3.9 billion in commitments managed by Fort Washington Capital Partners Group, a division.

Ty Hogan

Timothy (Ty) Hogan

Investment Manager
Ty is an Investment Manager for the Private Client Group. He has a Masters in Economics and a BS in Business Administration from Fordham University and holds the Chartered Alternative Investment Analyst (CAIA) designation. 

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