In layman’s terms, Fat Tail Risk is the low probability of assets suffering a decline in value of significant magnitude. Since these low probability / high magnitude market events can be devastating to portfolio value, many investors refer to the experience of a Fat Tail Risk event as a “permanent impairment of capital”. In capital markets, appreciation of Fat Tail Risk for most investors tends to ebb and flow in cycles that correlate to general market volatility. In other words, market participants tend to have short memories when times are good.
The final quarter of 2019 was one of the significant milestones and achievements for Liquid Strategies, marking the 6th full year of managing a conservative, risk-controlled option writing overlay program designed to add excess return to fully invested portfolios with a modest increase in overall portfolio volatility. In addition to applying the overlay program on top of existing client assets on a customized basis, the application of the Overlay expanded to provide separate account and packaged solutions (funds and ETFs) to allow the overlay to sit on top of six core underlying sources of beta: 1) Large Cap U.S. Equity; 2) Small Cap U.S. Equity; 3) Non-U.S. Equity 4) Core Bonds; 5) Municipal Bonds; and 6) Short-Duration Bonds. For investors that would have been invested in these various strategies since the inception of the firm, below are the illustrative long-term performance results:
ANNUALIZED SEPARATE ACCOUNT ILLUSTRATIVE RETURNS (Net1)
11/01/2013 - 12/31/2019
|1 YEARS||3 YEARS||5 YEARS||Inception to Date|
|Large Cap Equity + Overlay||34.35%||15.62%||13.90%||14.93%|
|S&P 500 Index||31.49%||15.27%||11.70%||12.68%|
|Small Cap Equity + Overlay||25.55%||8.72%||11.69%||11.86%|
|S&P 600 Index||22.78%||8.36%||9.56%||9.70%|
|Foreign Equity + Overlay||17.70%||10.74%||8.82%||8.05%|
|MSCI ACWI ex US||21.51%||9.87%||5.51%||3.95%|
|Core Bond + Overlay||11.25%||4.74%||5.36%||5.64%|
|Bbg Barc US Agg Index||8.72%||4.03%||3.05%||3.27%|
|Municipal Bond + Overlay||9.80%||4.96%||5.46%||6.25%|
|Bbg Barc Muni Bond Index||7.54%||4.72%||3.53%||4.23%|
1Net of fees assumes a 0.75% management fee applied monthly. These returns are illustrative, hypothetical numbers representative of two actual return streams (Liquid Strategies Overlay and the underlying index ETF). The numbers illustrate what would have happened had we taken the underlying index ETF returns and added Liquid Strategy Overlay returns to them. Source: Morningstar, Liquid Strategies.
OVERLAY + SHORT DURATION FIXED INCOME ANNUALIZED PERFORMANCE (Net2)
|1 YEAR||3 YEARS||5 YEARS||Inception to Date|
|Theta Income Strategy||6.90%||2.50%||3.36%||3.13%|
2Net of fees assumes a 1.00% management fee.
Everyone has heard the proverb “a bird in the hand is worth two in bush”. This most assuredly applies to income investing today. Too many investors are focused on the “second” bird in the bush, or the potential for equity appreciation.
The end of a year is always a good time to reflect on what just happened and try to take a guess as to what lies ahead. Coming off 2018 where nearly nothing worked in portfolios, this year has proven to be the exact opposite with all major asset classes posting positive returns through the end of November. Not only have the returns been positive, they have been exceptionally strong for both stocks and bonds.
The term “Overlay” has been used multiple ways in the investment management industry, but when we think of the term, we envision a fully-invested investment portfolio with an options-based strategy that sits on top of the portfolio. This overlay effectively converts a two-dimensional investment portfolio into a three-dimensional portfolio where the 3rd dimension (the options overlay) alters the risk/reward profile of the overall combined portfolio. Investors that utilize overlays generally do so with the goal of reshaping the potential investment outcomes with the most common goals being 1) generating supplemental income/return (typically through covered call or put writing strategies); and 2) reducing the risk of the existing portfolio beta exposure (typically through collar strategies).
In a choppy quarter marked by large moves within a defined trading range, the Theta Income Strategy was able to generate a net return of 1.26% for the quarter, bringing the YTD net return to 5.31%. On a longer-term basis, the Theta Income Strategy has the ability to generate attractive absolute and risk-adjusted returns relative to bonds partially due to focus on risk control and volatility mitigation in the Strategy. The volatility relationship between the Strategy and bonds continues to trend very favorably so far in 2019. From the start of the year through 9/30/19, the annualized standard deviation of the daily returns of Theta Income has been only 2.06% compared to 3.30% for the Bloomberg Barclay’s US Aggregate Bond Index. These results are supportive of our ongoing effort to generate the highest returns per unit of risk.
Topics: Theta Income
Although the quarter included a sharp volatility spike in May and overall large swings in the equity markets, the Theta Income Strategy was able to generate a net return of 0.94% for the 2nd quarter, bringing the YTD net return to 4.00%. On a longer-term basis, the Theta Income Strategy continues to provide compelling absolute and risk-adjusted returns relative to bonds.
Topics: Theta Income
The Theta Income Strategy was able to capitalize on the normalization of volatility to generate a solid net return of 3.02% for the 1st quarter after an extremely challenging environment in 2018. On a longer-term basis, the Theta Income Strategy continues to provide compelling absolute and risk-adjusted returns relative to bonds.
Topics: Theta Income