The US equity markets were up overall during the first quarter of 2021, but volatility remained the norm, as concerns about the Biden administration’s ability to pass fiscal stimulus and the FED’s ability to execute its “run-hotter” inflation policy gave the markets pause. During the quarter, Hedged Equity provided a 4.19% gross return and 3.73% net return vs the S&P 500’s 6.17% return. The strategy captured over 60% of the index’s Q1 return, while continuing to operate with substantially less volatility than the broad market – under 33% during 1Q21. The S&P 500 experienced multiple 3-5% drawdowns from short term peaks over the course of the quarter, but the strategy continued to provide the desired return profile, significantly tempering downside volatility and cross asset-class correlation, while maintaining targeted levels of equity participation as equity markets reverted upwards. Given the concerns around COVID-19 variants, the vaccine rollout, high equity valuations, potential tax increases, and steepening yield curves, we consider Hedged Equity as well positioned to provide solid risk-adjusted returns in a backdrop of continued volatility.
The combination of improved fundamentals and laissez-faire FED policy were recognized by the market, resulting in the VIX dropping throughout the quarter. Although it fell from the low-30s to the high-teens, the VIX remains at historically high levels. Hedged Equity’s investment team continues to maintain our systematic protection and short duration derivative structure, setting us up for heightened volatility and any potential down-market scenarios. While volatility generally dropped through the period, the spikes experienced in late-January and February through early-March provided opportunities for the portfolio to limit drawdowns, defending non-linearly and improving upside equity participation.
Looking ahead, we believe managing risk exposures should be at the forefront of investor minds, due in part to the prospect of US interest rates normalizing as the lingering effects of COVID-19 are overcome and the chance that higher rates bring potential for higher tax rates. Unfortunately, this has the potential to heighten some of the tapering concerns we saw in late-February, which is a prospect that should not be ignored. If US treasury yields do rise in response to better economic data and increased supply, the implications of rising yields could be impactful to corporate and high yield securities. We think the next few months will bring greater clarity to these issues and another increase in volatility should not be unexpected. Certainly, the systematic approach we take works to reduce the depth and duration of drawdowns in equity market declines. That said, we think investors should consider their credit exposures as they evaluate the equity correlation risk across their portfolios and consider bolstering risk mitigating positions. We have previously shared in-house studies which show that increasing allocation to risk mitigating strategies, such as Hedged Equity, can help to offset the increasing risks of market decline when investors use higher-Beta or equity-related risk profile strategies. As always, we are available to discuss these concepts.
Returns are gross-of-fees representative account. Easterly EAB Risk Solutions LLC is an investment adviser registered with the SEC. Registration does not imply a certain level of skill or training. All information in this communication has been obtained from sources believed to be reliable but cannot be guaranteed. There can be no assurance that the investment objective for these strategies can be achieved and past performance is no guarantee of future results. The S&P 500 is an index of unmanaged securities, and the indices are not securities that can be purchased or sold.