Aptus has six team members that are former collegiate basketball players and two that went on to play professionally. That is almost 50% of our roster. This shared background creates a competitive culture and basketball analogies as a go-to for simplifying the complex.
The subject of simplification today – hedging.
Given the current backdrop for investors…the stock market is near highs, the VIX (the market’s fear gauge) is back down in the teens, yields on junk bonds are as close to yields on government bonds as we have seen…we think it’s time to revisit hedging as a critical component of our portfolio construction process and Drawdown Patrol mentality.
But first, let’s talk hoops.
Skill Assessments
If you want to win games as a college coach, you must be able to recruit. Coaches spend so much of their off season trying to find and court good players to their campus.
Coaches can watch players in game settings, or they can watch players as they go through individual workouts. Two totally different environments for evaluation of talent.
Individual workouts isolate the player. Can they shoot, can they pass, can they handle the rock, etc. There is no place to hide during an individual workout – your skills, or lack thereof, are on full display.
Ronald Nored
I had the privilege of playing high school basketball and competing in college with Ronald Nored. In fact, I had the opportunity to pick him up and drop him off from practice most days. He is still a great friend and now an assistant coach for the Charlotte Hornets.
Ron, if you read this…I am sorry for the next couple of sentences, but keep reading, it gets better.
Ronald would not evaluate out to be a great player based on an individual workout or skills assessment. He would not pass the eye test…he is short. He has a decent handle, but not great, and to top it off, he is not going to win any shooting contests!
An individual workout would leave Ronald off most recruiting lists, which makes the next part even better…
See, Ron was the starting point guard for the Butler teams that went to back-to-back National Championship games and were an inch away from beating Duke to win it all. Sure, they had some good players, but if you remove Ron from the roster there’s ZERO chance, they made those runs…ZERO.
What an individual workout designed for skill assessment fails to register is Ron’s impact on the overall team – the intangibles. His ability to guard. His ability to move the ball where it needs to go. His ability to make those around him better as a floor general. His energy, his leadership…Ron brought more of those intangibles to the floor than almost any player I’ve seen. Butler would not be Butler without a short kid from Homewood that cannot shoot.
While not a 5-star in a vacuum, Ron’s presence transformed the potential of the team.
Team over Individuals
Building a good team is easier to do with good players, but having the right good players matters even more.
The definition of good should be different for each player. Kyrie Irving is a good player. A team full of Kyrie Irvings is a bad team. You cannot complete a puzzle without the right pieces.
When assessing a player, you cannot focus purely on some skills assessment ranking. It’s the way the player could complement the other pieces you have in place. The best teams have the right pieces, not the best players.
This is a truth we see play out in March each year. It is the culprit of the Madness!
Abilene Christian beat Texas in the first round. Sure, Texas had more talent, but Abilene Christian had a better blend of talent.
Hedging in our Portfolios
Hopefully, you see where I’m going here to tie in this hoops analogy…
In my opinion, the best characteristic of a basketball player is the ability to make those around them better. We think hedges can play a similar role in portfolios.
On a standalone basis, hedging does not look all that appealing. Remember, hedges are designed to go up when the markets go down. In most cases, markets go up, so hedges go down. So why hedge? Because of what we think it can do for an overall portfolio – the potential for overall positioning that can improve return, and the chance to reduce drawdown in the environments that worry investors most.
From a return standpoint – the presence of hedging allows us to own less bonds and more stocks which we believe improves potential for returns in a meaningful way…especially in today’s market.
From a risk standpoint – the presence of hedging is intended to defend against both longevity risk (the risk of running out of money) and drawdown risk (peak to trough drops in account value). Longevity risk is defended by producing higher returns…see the paragraph above. Drawdown risk comes to the surface during periods of high volatility. These are the exact periods that hedges produce the most convex payoffs.
Hedges as a team member transform the relationship between return & risk.
Moving Forward
Today’s focus is not on the how of hedging or why we like convex payoffs or how we leverage our derivative expertise to provide hedging to portfolios and strategies.
It’s simply a reminder of why we hedge!
We wanted to provide a simple analogy of why we build portfolios the way we do and how crucial hedged strategies are to our process:
- The team matters more than the individual parts. While a diversified portfolio will almost always contain a player (holding) or two that did not perform well in isolation, their impact may have brought other unseen benefits.
- Markets are rising and volatility is dropping. Our exposure to hedging is still there and not going anywhere. We believe it positions us to effectively (within each portfolio’s risk constraints) participate in friendly market and protect during the storms.
As portfolio coaches constantly evaluating talent to piece together the right team, we like how we are positioned for this environment.
We see hedges as our “glue guy” who can make everybody around them better.
As always, thanks for your trust and please do not hesitate to reach out with any questions.
Disclosures
Past performance is not indicative of future results. This material is not financial advice or an offer to sell any product. The information contained herein should not be considered a recommendation to purchase or sell any particular security. Forward looking statements cannot be guaranteed.
This commentary offers generalized research, not personalized investment advice. It is for informational purposes only and does not constitute a complete description of our investment services or performance. Nothing in this commentary should be interpreted to state or imply that past results are an indication of future investment returns. All investments involve risk and unless otherwise stated, are not guaranteed. Be sure to consult with an investment & tax professional before implementing any investment strategy. Investing involves risk. Principal loss is possible.
Advisory services offered through Aptus Capital Advisors, LLC, a Registered Investment Adviser registered with the Securities and Exchange Commission. Registration does not imply a certain level or skill or training. More information about the advisor, its investment strategies and objectives, is included in the firm’s Form ADV Part 2, which can be obtained, at no charge, by calling (251) 517-7198. Aptus Capital Advisors, LLC is headquartered in Fairhope, Alabama. ACA-2105-3.
