2020 vs 2022 Two very different bears

It goes without saying that protective strategies need to work in bear markets – but a review of three traditionally defensive strategies during the past two major drawdowns shows very mixed results. Depending upon the market conditions, some strategies worked and some failed.

In the charts below we use style indexes to illustrate the different returns during these two drawdown events with returns of the S&P500 Index. The strategies represented are:

  • Tail hedging – represented by the S&P500 5% Put Protection Index (PPUT). This Index pairs ownership of the S&P500 with a monthly protective put option with a strike 5% out-of-the-money.
  • BuyWrite overlay – represented by the S&P500 BuyWrite Index (BXM). This Index pairs ownership of the S&P500 with the sale of a monthly call option with a strike at-the-money.
  • Value style – represented by the S&P500 Value Index


2020 Drawdown

During the aggressive Coronavirus selldown where the market fell over 35% from its high in just a few weeks, protective tail hedging strategies were worth their weight in gold. The bought put options with strikes only 5% below the market were very quickly demonstrating their protective properties during a crisis, nearly fully insulating the portfolio during the worst of the downturn.

By comparison, Overlay and Value strategies underperformed, offering little to no protection at all.

Overlays are not well suited to providing protection during aggressive sell offs, as the income generation offers only a limited defensive buffer in a short, sharp sell off. Furthermore, Value also underperformed as the rotation of demand into more stay-at-home type activities, plus aggressive monetary and fiscal easing, both served to benefit Growth/technology exposures over Value. 


2022 Drawdown (to date)

How things changed! So far in the current drawdown, Overlay and Value strategies have roughly halved the market losses, bearing in mind that losses are far shallower than in 2020. During this drawdown the combination of a far more gradual sell-off which allowed more time for income generation helped to meaningfully buffer losses. Combined with a tightening Fed policy to combat inflation, Value strategies also delivered a good result in terms of capital preservation.

By comparison in this more recent drawdown, tail hedging strategies effectively delivered zero value (even with only a 5% out-of-the-money strike), as the market falls were just too shallow and took far longer to materialise (combined with elevated volatility which made hedging more expensive).


Is there a lesson for what is the best approach? 

What seems clear is that there is no one single defensive investment strategy that works in every market environment. We might add to this list the exposure to the Australian dollar, which is ‘usually’ defensive and falls during a market crash, but as we saw during February this year, is not always a reliable defensive partner (and can make things worse).

We could sit in cash of course and enjoy a guaranteed defensive exposure, however the low returns would also guarantee (for most of us) that we would fail to achieve our investment goals.

Thus in order to target equity returns but with much better drawdown characteristics, it makes sense to diversify across defensive strategies that are better suited to a range of market environments.


An example of defensive diversification 

In the Wheelhouse Global Fund we rely on tail hedging for more acute market falls, plus a systematic BuyWrite overlay for more ‘grind down’ scenarios that take longer to manifest. We acknowledge we don’t know what the next drawdown will look like, or how long it will take, so we rely on diversification of defensive approaches to deliver a highly reliable defensive profile that is designed to nearly halve losses across any type of drawdown.

When paired with a fully invested and generally balanced (Growth/Value) equity portfolio, the end result is expected to be highly reliable – with no surprises when you can least afford them.

The charts below plot the defensive characteristics across the same time periods as above.

The Global fund was slightly positive during the 2020 drawdown and is 7% down during the current bear market. On a USD basis which removes the impact of currency, the fund caught 53% of the drawdown in 2020 and 57% of the drawdown in 2022, both of which are consistent with our risk management targeting.

However the main source of protection across both drawdowns was very different. Similar to the Style Index returns above, most of the defensive benefits were delivered by the tail hedge in 2020 and then by the Overlay in 2022. Through active risk management of Overlay and Tail hedge, the drawdown outcome remained highly reliable regardless of the market environment.

As the portfolio is unhedged from a currency perspective, it also usually benefits during drawdowns as the AUD usually declines. As we discussed in our February newsletter (‘Australian Dollar: Friend or foe’), this defensive characteristic is less reliable than the risks we can otherwise control via Tail hedging and Overlay strategies. We are investigating ways of managing this exposure better internally, and importantly seeking to reduce the currency drag when markets recover.

One large bet we don’t make is Value vs Growth, as we believe this one can be a little unpredictable (and tends to mean revert over time anyway). Through incorporating defensive strategies like tail hedging that are designed for sudden acute drops, or overlays that are better suited for much slower market grind down environments, we remove the need to try and second guess which types of stocks or sectors are likely to prove defensive.


So where to from here? 

There are a number of benefits that result from minimising drawdowns that we won’t go through here. However, minimising drawdowns is only half the story, as we also need to maximise our participation as and when markets recover. Remaining fully invested and not trying to time market rebounds ensures that what happens from this point is treated as equally important to the performance in getting here.


This communication is for Wholesale investors only and has been prepared by Wheelhouse Investment Partners Pty Ltd (ABN 26 618 156 200), a Corporate Authorised Representative (CAR 001253586) of Perpetual Corporate Trust Limited (ABN 99 000 341 533) AFSL 392673. It is general information only and is not intended to provide you with financial advice or take into account your objectives, financial situation or needs.

Past returns are not an indicator of future returns. You should consider, with a financial adviser, whether the information is suitable for your circumstances. To the extent permitted by law, no liability is accepted for any loss or damage as a result of any reliance on this information.

The product disclosure statement (PDS) for the Wheelhouse Global Equity Income Fund, issued by The Trust Company (RE Services) Limited, should be considered before deciding whether to acquire or hold units in the fund. The PDS and TMD can be obtained by calling +61 7 3041 4224 or visiting www.wheelhouse-partners.com. No company in the Perpetual Group (Perpetual Limited ABN 86 000 431 827 and its subsidiaries) guarantees the performance of any fund or the return of an investor’s capital.

Want to keep your dividends but reduce risk?

Ready to eat dividends?

Australian equities are likely to underperform the world market over the next five years, according to the Blackrock Investment Institute. Local market returns are expected to average 4.5% over these years, compared with 6% for US markets, and 9% for Europe.

Fig 1: Blackrock five-year return forecasts (Data as of 24/1/22)

While we have chosen to focus on Blackrock’s estimates (for those interested, their interactive website is excellent), the forecasts are similar to those of other major global fund managers and asset consultants. Put simply, it’s hard to be bullish when most believe we’re entering a global tightening cycle.

If these forecasts are accurate, the reality for many Australian investors is that dividends will make up nearly 100% of expected total returns from equities over this period. Capital growth would likely prove negligible, as the positive effects from earnings growth are largely offset by falling valuations (as rates rise, valuations typically fall).

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Can dividends deliver outperformance?

It’s no secret that Australian investors love their dividends. But recent Morningstar research has found that a portfolio of higher dividend-paying shares actually meaningfully outperforms over the long term.

But by how much, you ask? Great question.

Over a 45 year period, the research house found that Aussie dividend payers beat the S&P/ASX 200 benchmark by 3.7%, on average, every single year, delivering investors a return of 14.8% per annum.

Unfortunately, getting the right exposure to these Aussie high yielders isn’t as easy as one may think. We reviewed the performance of the largest six “dividend” or “high yield” ETFs available locally, and all but one have underperformed the S&P/ASX 200.

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Income Efficiency – increasing yield whist minimising risk

  • Meagre yields from cash/bonds have left many investors reducing their usual weights to these defensive assets insearch of more acceptable returns.
  • Investors have been pushed further along the risk curve and forced to shoulder meaningfully higher capital risk.
  • Wheelhouse Global targets enhanced income efficiency – increasing income whilst minimising additional risk.

Source: Wheelhouse, Morningstar Direct. Asset proxies: S&P Australian Government Bond Index, S&P Australian Corporate Bond Index, Betashares Hybrid ETF, Vanguard Aust Property Securities ETF, S&P/ASX 200 Index, MSCI World ex Aust (AUD).

Risk-Efficent Income

Enhancing income yields typically entails some level of higher risk. By comparing yields across different asset classes, income can be evaluated alongside the associated increase in risk.

Selecting investments above the line should assist in building a more risk-efficient income portfolio.

Source: Wheelhouse. Investor B assumes 20% allocation to Wheelhouse Global

Scenario Analysis

  • Investor A: $250,000 invested in term deposit yielding 0.55% pa, and;
  • Investor B: $200,000 invested in term deposit yielding 0.55% pa, plus $50,000 invested in Wheelhouse Global yielding 8.0% pa.

By introducing a 20% allocation to Wheelhouse Global from the investor’s cash allocation, the income yield increases 3.7x from $1,375 to $5,100 pa.

Of equal importance, the portfolio risk only increases from zero to 0.9, or less than one-tenth the risk of being fully invested in Australian equities.

The Wheelhouse Global Fund’s strategy was specifically designed with income efficiency in mind.

The Fund objective is to deliver a 7-8% income yield, while assuming half the risk of equity markets. As a result the Fund is the lowest risk equity fund in the Morningstar long-only universe, but also one of the highest yielding.

For more information on Wheelhouse and their income funds please refer www.wheelhouse-partners.com

Pfizer’s jab costs $35… versus $3 for AstraZeneca’s. Sound fair?

When receiving my jab last month (thankyou nurses at RBWH in Brisbane for your excellent care!) I couldn’t help wondering how much all these vaccines were costing.

From a purely supply and demand perspective, the drug companies should be able to name their price. How much would our government have paid for an extra 1m Pfizer doses delivered two months ago? How much did we pay Poland on the secondary market for 1m does last week?

So how much are they?

As it turns out, the answer depends upon what brand you receive.

Reported global prices for Pfizer are around AUD$35 per jab and AstraZeneca are around AUD$3. The price difference is staggering when put in context of the billions of doses required to vaccinate most of the global population.

Why so different?

The price difference is due to the vastly different profit motives for this particular vaccine. AstraZeneca is pricing their Covid vaccine on a not-for-profit basis, at least until the pandemic is under control. Johnson & Johnson have done the same with their Covid vaccine.

However Pfizer, Moderna and Novavax have made no such election and are generating profits… very large profits.

In the recent Pfizer 2Q earnings release, Pfizer upgraded 2021 revenue expectations for their Covid vaccine to US$27bn, which at that level will account for nearly one-third of the companies entire annual revenue. For AZN, the profit impact is expected to be zero.

The profitability of Pfizer’s Covid vaccine is impacting the share price. Year to date the shares are up nearly 40%, versus AZN only up 20% (in USD).


We own both Pfizer and AstraZeneca in our Global fund, and we contacted the Morningstar Healthcare Analyst in Chicago about what we felt was a potential ESG concern on pricing.

Read full article here

Vale David Swensen – Lessons from a pioneer of Endowment investing

Legendary but perhaps lesser-known investor David Swensen passed away earlier this month. Mr Swensen had been the CIO of the Yale University Endowment since 1985 – so over 35 years – and is credited with inventing an entirely different way of investing for institutions and specifically for Endowments.

During his tenure the Endowment at Yale grew from $1bn to over $30bn, with the value creation during this period over $45bn if all distributions paid to the University are included.

These returns far outstripped that of all other Universities and most institutional funds, many of whom were managing their portfolios on a more traditional 60/40 (equity/bonds) investment approach. Over time, many of these institutions attempted to replicate the Yale model, with varying levels of success.

Just as important as the total return generation of the Fund has been the provision of funding for the University across a variety of market environments. This funding has become increasingly critical to the University’s growth and success as the Endowment now provides one-third of the entire Yale University operating budget (as per 2020) which is a significant increase from 10% in 1985. This achievement is all the more remarkable given the massive growth in operating budgets and tuition fees in addition to the fact that the Endowment now provides financial aid for more than half of Yale’s students.

Read the full article here

US dividends may get a boost from Biden tax plan

US shares have rarely been high on an income investor’s wishlist, with average dividend yields for the S&P 500 Index meaningfully trailing the ASX 200 Index and other markets for decades. However, US companies are no less cash generative. Instead, share buybacks have been the primary mechanism for ‘returning’ cash to shareholders. When buybacks are included, US shares have consistently ‘yielded’ higher than Australian shares.

With the Biden Administration’s proposed changes to capital gains taxation underfoot, this may spark a rethink amongst US corporates regarding dividend policy.

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Protection finally cheaper just as markets push higher

With markets testing new all-time highs, volatility is finally starting to decline with the VIX Index recently touching post-Covid lows, closing near 16 on Friday. This is good news for investors who wish to remain invested but who may want to de-risk their portfolios and lock in some of the massive gains of the past 12 months.

Continue Reading…

Wheelhouse Global Equity Income Fund added to BT Wrap and BT Panorama platforms

The flagship fund of Australian-based specialist income manager Wheelhouse Partners, the Wheelhouse Global Equity Fund, is now available to Australian retail investors through the BT Wrap and BT Panorama platforms.

The Fund is unique in that it combines a targeted 7-8% income return with ‘always-on’ tail or crash protection, designed to partially protect the portfolio during any market sell off.

Alastair MacLeod, Managing Director of Wheelhouse Partners, commented, “With equity markets approaching all-time highs and interest rates at all-time lows, the demand for strategies with an absolute return focus is increasing.

Read full article here…