January 2022 was a turbulent month, with volatility and valuation pressure appearing during the first week of the New Year and lasting most of the month, until a late-month 4% rally spared investors from a much worse fate. During the period, Hedged Equity outperformed the S&P 500, returning -1.32% gross of fees (-1.43% net of fees) versus -5.17%, avoiding over 74% of the market’s decline. The reality of a hawkish Federal Reserve interest rate and balance sheet normalization process began to impact front-end US treasury rates and equities more clearly. That actuality also impaired the bond market’s ability to provide diversification with high yield, investment grade, and long US treasuries underperforming our strategy for the month as well. With expected 2022 rate hikes moving from 3 to 5 (or more), the thought that the FED would accelerate reduction in its balance sheet fostered a view that a roll over in US growth was more distinct than previously forecast. Initially, equity declines were primarily felt in the higher PE and tech sectors of the market, but as the month progressed, equity volatility levels rose (VIX from ~17 to 32) and more generalized equity bearishness occurred. As is consistent with our approach, Hedged Equity outperformed during the period, benefitting both from our overweighted put spread positioning in the -2 to-7% target decline zone and our sensitivity to volatility as declines increase.
Our performance for the period was predictable and we believe that so long as uncertainties remain around inflation levels and how FED policy is executed, that our approach will serve as an excellent portfolio diversifier. It’s also important to note that a characteristic of the strategy, to be increasing equity exposure as market declines progress (and to be reducing exposure as the S&P rises), has historically allowed the strategy to recover well once the decline reverts. While we foresee a period of volatility ebbs and flows that can be advantageous to the strategy’s defensive characteristics, we also believe that the economic cycle will eventually stabilize into a rotation that allows equities to garner solid returns. During this market cycle, as in others, we expect to deliver meaningful total returns but most importantly, provide superior risk-adjusted returns that help balance our clients’ overall portfolio risk.
*Performance is Hedged Equity Composite gross-of-fees.
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