A perfectly timed portfolio booster

When you're amid a market decline, you're never quite sure if you're riding out a dip or on the precipice of a deeper downturn. It may not be the next financial crisis, but you can certainly sustain hefty losses during these periods and it can take a long time to recover. It would be nice to have a neat strategy to manage that risk. 

I recently spoke with Stephen Coltman, senior investment manager on the Alternative Investment Strategies team at abrdn Investments about its Global Risk Mitigation (GRM) index and the role alternatives can play in your portfolio. 

The GRM index is comprised of approximately 30 actively managed derivative strategies and has performed strongly since its launch.

"(GRM) is a defensive strategy that aims to deliver a downside beta to equities of -0.2 or lower," Coltman says. "This means that if the equity market falls by 10%, we expect the GRM strategy to deliver a minimum positive return of 2%," according to the strategy guide."

"We have a very consistent profile, so we're always hedging. We're always trying to manage the most efficient hedge." 

I've never met a fund manager who likes to whip out a crystal ball and tell you what will happen next in markets. But all will say that at some point or another, a downturn, correction or black swan event is likely in your lifetime.

Managed Fund

Aberdeen Standard Global Risk Mitigation

Alternative Assets

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Grabbing risk by the tail 

In order to achieve the most efficient hedge, there are a few key determinants. One is how well the fund performs at the left tail (losses) and right tails (gains). 

"What is the problem that we're trying to solve for people? If you're looking at your long-term performance, how you perform in the tails is really important," Coltman says. 

Most investors are heavily focused on left tail risk. Am I going to lose? It's what keeps investors up at night. It even became Warren Buffett's number one and number two rules on investing. 

But there's also the risk of not capturing the upside of very strong returns in an outlier year on the right-hand tail, Coltman explains. You also want to be able to participate in the upside.

"The intention behind Global Risk Mitigation is to have a strategy that gives you a return profile similar to that of just buying a put," Coltman says.

"So if you're buying a put on your equities, for example, you'll get significant risk reduction and you'll have a low draw-down in that tail. But the cost of those premiums are quite high and the cost you're paying during more benign periods actually offsets a lot of the benefit you get from that. 

"What we're trying to do with the (GRM) strategy here is to have a similar overall return profile, but reduce that cost of ownership during more benign periods."

Birth, death and taxes... plus rate hikes 

Only three things are certain in life, they say. But rate hikes are so often fretted over in markets today that the impending doom of its arrival will hang over your investments as certainly as the other three. Even now, bond yields in the US are wreaking havoc in markets over likely rate movements. It can feel inescapable.  

"If you look at the world today, diversification is more difficult," Coltman says. "We have seen an increase in the correlation between bonds and equities, and even historically defensive assets like gold. And the returns on defensive assets, like high quality, fixed income, are extremely low." 

One of the other key features to mitigate risk is convexity. You'll see this mentioned often alongside defensive strategies, but it is truly critical to maintain balance. The objective is to have convexity that performs well through volatile markets while minimising the overall cost of ownership if equity markets don’t move significantly.  

There's typically a cost to own a hedging strategy that’s typically perceived as a combination of an opportunity cost and a negative carry (similar to buying insurance) which accumulates through time; this is especially true when it comes to investing in derivatives, Coltman says. "However we’ve sought to address this as the fund has convexity that performs well in the tails but also defensive strategies that can provide positive returns during more stable market periods."

What is the GRM-investible universe? 

GRM uses derivatives to create these strategies. In terms of investing, there is the index itself and a three-times leveraged version as well. 

"We bring together a range of systematically implemented derivative strategies across multiple asset classes and manage them to create the overall return profile we are looking for," Coltman says. "The objective is to construct a diversified and robust portfolio that provides an efficient portfolio hedge across a wide range of bear market scenarios." 

Coltman sees GRM as positioned as the defensive portion in the traditional barbell approach to building portfolios. 

"It can make sense for investors to have more of a barbell approach where they focus more of their exposures on those high conviction investment areas that they have while at the same time allocating to explicit hedges that they know will have a negative correlation and to help to reduce drawdowns and have less exposure to these assets that have very low expected returns," Coltman says. 

Investors may not have a crystal ball, but they certainly can appreciate a seer-like investment to mitigate that risk when it comes. 

Risk mitigation – a better “alternative”

The Global Risk Mitigation Fund (GRM) offers investors an efficient hedge to reduce exposure to major developed market equity drawdowns. Learn more below.

Managed Fund

Aberdeen Standard Global Risk Mitigation

Alternative Assets

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