One of the most important parts of evaluating a strategy is to appropriately set target returns and develop a good benchmark to measure relative performance. Without a known target, measuring performance internally is difficult. Without an appropriate benchmark, measuring against the competition is impossible. In order to do this, we need to break the Anchor strategy down into its key components for evaluation. Anchor is comprised of:
- A long ETF position that is typically 88%-92% of the total investment;
- A long put position that is typically 7%-10% of the investment for the hedge; and
- A short put position that makes up the balance to attempt to pay for the hedge.
When Anchor was originally devised our goal was to slightly lag the markets in up years, stay level in flat market returns, and beat the market significantly in down years. That worked in years the market was up ten percent or less, which was the primary evaluation period. However, the past several years of bull markets have demonstrated that the term “slight lag” is not realistic or appropriate in large up markets.
Given the fact that Anchor is only approximately 90% long at any given time, we automatically are behind bull market performance. For example, if the market goes up 20%, Anchor’s long ETF position would only go up 18%. Couple that with the fact that in significant up trending markets, the long hedge rolls multiple times per year and you end up with larger lags in rising markets – which get more pronounced the faster the market is rising. A more effective measurement would be to compare to a more risk managed product, such as your traditional 60/40 stock/bond portfolio. However, even that is not an ideal metric, as Anchor should significantly outperform it in bear markets, making comparisons difficult.
Over the past few months I’ve been exposed to Swan Global Investment’s Defined Risk Strategy, which is remarkably similar to Anchor (except, as shown below, Anchor tends to perform better). Swan solves the goal defining issue through a “Target Return Band” shown below:
The theory being that their Defined Risk Strategy should fall within or above the blue range. The red line represents the theoretical return of the S&P 500, the yellow line is the Swan’s Defined Risk Return target returns when contrasted with the S&P 500 return at the point.
It is our opinion that these target bands represent a much more adequate projection of what results should be expected internally of the Anchor strategy. We will of course always work to exceed those expectations, but this will represent more realistic return projections for Anchor, particularly in large bull scenarios.
Another advantage to evaluating Swan’s Defined Risk Strategy, is it now gives us an appropriate benchmark to measure against. In describing their product, Swan states:
“Investing to help minimize downside risk. The market is unpredictable, making it difficult to time the markets or consistently pick outperforming stocks. That’s why we believe reducing downside risk can significantly impact wealth creation.”
“The goal: to achieve positive returns while minimizing the downside risk of the equities markets.”
“Key strategy elements to each of the Defined Risk Funds include:
- No reliance on market timing or stock selection
- Designed to seek consistent returns
- Aims to protect client assets during market downturns
- Always hedged, all the time, using put options”
“Repeatable Four Step Investment Process
Step 1: Establish Equities (using diverse ETFs)
Step 2: Create the Hedge – Always hedged – We use only longer term puts, which offer the greatest cost-efficiency and stability, and then maintain that protection by rolling the hedge at least annually. As such, the DRS (Swan’s Defined Risk Strategy) is not under duress to seek protection in market downturns.
Step 3: Seek to Generate Market-Neutral Cash Flow – We use options-trading expertise to provide our clients with the potential for return, regardless of market conditions.
Step 4: Monitor and Adjust”
To anyone who has used Anchor, this should all sound familiar. In identifying competition, we have yet to identify any other product, other than Swan’s, that is a “true” competitor for Anchor. As a competitor, using them as our benchmark is ideal. Further, as Swan’s track record is significantly longer (going back to 1997) than Anchor it provides validation to the Anchor strategy. Swan’s Class I shares have returned the following (courtesy Morningstar) since 2013:
As quickly can be seen, Anchor is slightly outperforming a fund that has over one billion dollars in assets that is setup to do virtually the exact same thing as Anchor – and Anchor continues to evolve, always trying to tweak out a few more basis points of performance.
Note that the Morningstar returns are net returns while Anchor’s are gross, which does account for some of the difference in performance. Class I shares were chosen over A, as Class A shares have additional charges in them that further skewed the results. Also Anchor’s 2013 returns were dramatically helped by using individual stocks which outperformed the market, as opposed to ETFs, which we now use.
In short, while there are justifiably frustrations that Anchor has been lagging the market in the amount it did through 2016 and 2017, we believe that is not so much a design flaw in Anchor, as a flaw we made in setting expectations. Moving forward, we will benchmark our performance to Swan and hope to continue to outperform their products and meet or exceed our target bands.
If you have any questions about the Anchor Strategy, how to implement it on your own, or wish us to manage such positions for you, contact my firm at anytime or make a post on the SteadyOptions website:
Christopher Welsh: firstname.lastname@example.org
Jesse Blom: email@example.com