STOCKS: Swan Global In­vest­ments uses a hy­brid ap­proach to man­ag­ing mar­ket risks.

The Denver Post - - BUSINESS - By Alex Veiga

Mu­tual funds’ in­vest­ment strate­gies can vary widely, with some fo­cus­ing on ag­gres­sive growth, while oth­ers have a less risky style that would ap­peal to fixed-in­come in­vestors.

Then there are funds like Swan Global In­vest­ment’s De­fined Risk Fund, which take a hy­brid ap­proach.

The fund, which launched in 2012, in­vests pri­mar­ily in ex­change-traded funds, or ETFS, but also plays the op­tions mar­ket with the goal of hedg­ing against big mar­ket slumps.

The fund is up about 3 per­cent this year, ac­cord­ing to Fact­set.

Randy Swan, lead port­fo­lio man­ager of the fund, ex­plains the fund’s strat­egy and why he be­lieves it’s a bet­ter way to make gains while re­duc­ing in­vest­ment risk when a bear mar­ket hits.

An­swers have been edited for length and clar­ity:

Q : Ex­plain your fund’s in­vest­ment strat­egy.

A: I started the strat­egy about 20 years ago, and what it’s re­ally de­signed to do is we ac­tu­ally go in the op­tions mar­ket and buy long-dated op­tions to hedge out most of the down­side ex­po­sure on an an­nual ba­sis.

Q : How do you ac­com­plish that? A: We go out and we take a hedge po­si­tion. When you buy a put op­tion, you’re ac­tu­ally able to de­fine that risk on a much more con­sis­tent, more con­fi­dent level to be able to hedge out that risk. (A put op­tion is a con­tract that gives the owner the op­tion to sell a se­cu­rity at a pre­set price and pe­riod of time.)

For ex­am­ple, if the mar­ket is go­ing to go down like in 2008, 35 to 40 per­cent, then you know ex­actly what that put op­tion is go­ing to do to pro­tect that as­set. It’s much more reli­able and con­sis­tent.

We usu­ally buy op­tions at about two years. But at the end of ev­ery year, what we’ll do is we’ll sell all our cur­rent op­tions and re-hedge us­ing two-year put op­tions.

That al­lows us to go through bull mar­kets, lock­ing in higher and higher lev­els in the mar­ket. And when you go through bear mar­kets, you’re able to ad­just the strike price down and take the prof­its on the sale of those put op­tions.

Q : How do you bal­ance hedg­ing with in­vest­ing in ETFS?

A: About 90 per­cent of the un­der­ly­ing port­fo­lio gets in­vested in ETFS and about 10 per­cent goes into long-dated put op­tions. The sec­ond com­po­nent of the strat­egy is we sell short-term op­tions against those long po­si­tions.

Just as we like to hedge us­ing longer­dated op­tions, we like to try to gen­er­ate in­come by sell­ing shorter-dated op­tions against those po­si­tions.

Q : The fund is meant to pro­tect against big mar­ket drops, but is it ideal for long bull mar­kets like the one we’re cur­rently in?

A: We think, and the re­search proves this, if you’re able to avoid the big losses in down years, you’re able to out­per­form over the long haul. The fund is very de­fen­sive in na­ture.

Our SMA (sep­a­rately man­aged ac­count) track record, which goes back 20 years, ac­tu­ally has out­per­formed the S&P 500 with less risk. We’re not look­ing at say­ing that we’re go­ing to out­per­form the mar­ket on up years. But we think over full mar­ket cy­cles, it’s still com­pelling to pro­tect.

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