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Is Anti-Beta (Market Neutral) Effective?

Our current income portfolios: 

DFMAP (Dividend Focused Multi-Asset Portfolio) 
TAC (Treasuries Across the Curve)
VWI (Volatility Weighted Income)

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We were quoted in an American Banker article discussing the tough secular outlook for regional banks. It would be hard to find another sector at such a disadvantage in the digital economy. (Link)

With the equity market becoming frothy and trending higher in volatility this year, we’ve had a number of conversations around adding “anti-beta” to the portfolio to 1) protect gains and 2) reduce volatility. There’s a few ways to do this and largely depends on the portfolio objective and risk tolerance. 

Effective portfolio construction delivers superior risk-adjusted returns. This involves assets that individually have high risk-adjusted returns and low correlation which further reduces portfolio volatility (our optimization methodology). An optimized portfolio delivers this while dynamically adjusting to changing market conditions.

Owning downside protection is conceptually similar to owning insurance. This involves buying out-of-the-money options that can deliver a big return if an extremely adverse market event happens but most of the time loses the premium. The net result is a drag on the portfolio but provides liquidity when it is most needed. 

Market neutral strategies have been around for some time and come in many flavors. They are generally built around long/short in a specific asset class or absolute total return. It is difficult to get above a money market rate of return without taking on some level of market volatility. How efficient that portfolio is relative to the volatility should be the key question. With money market rates above 5%, the cash returns doesn't look terrible.

A portfolio is ineffective if the assets are highly correlated and remain highly correlated. The Wall Street Journal highlighted this on Thursday as higher bond yields drove underperformance in sectors with high income exposure: real estate, utilities, and consumer staples. 

Perhaps the bigger point is that a market-cap or equal weight portfolio leaves a lot to be desired for investors in portfolio construction.

As always your thoughts and feedback are very much appreciated!


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