The Case for the DRS as a Core Equity Solution - Bitly

Jun 6, 2017 - Although the DRS was originally designed to be a total portfolio solution, Swan. Global Investments realizes it is unlikely that many people will ...
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The Case for the DRS as a Core Equity Solution Blog Series - Where the DRS Fits

Marc Odo, CFA®, CAIA®, CIPM®, CFP® | June 6, 2017 | Swan Blog

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Although the DRS was originally designed to be a total portfolio solution, Swan Global Investments realizes it is unlikely that many people will place 100% of their money in the DRS. One of the most frequently asked questions regarding the Defined Risk Strategy is, “Where does the DRS fit?” While it is true that the DRS can perform many different roles within a portfolio, we tend to position the DRS first and foremost as a core equity solution. The flagship DRS solution, with its inception in July 1997, is based on large cap U.S. equity. Although the DRS is now offered upon other asset classes like small cap equity, foreign developed, and emerging markets, the flagship offering has always utilized U.S. large cap ETFs for its equity exposure. Typically, the DRS holds 85%-90% of its positions in ETFs. One can make the case that the DRS is fundamentally a core equity position, with the hedge and income components overlaid on top of it. If one were to compare the portfolio characteristics of the Swan Defined Risk Strategy Select Composite against the S&P 500 index and the Morningstar category for Large Blend, the DRS is right in line with other core, large cap equity offerings. Asset Allocation, 3/31/17 Cash US Stock Non US Stock Bond Other

Swan DRS (%net) 2.94% 96.42% 0.64% 0.00% 0.00%

S&P 500

Swan DRS (%net) 38.86% 43.50% 17.52% 0.12% 0.00%

S&P 500

0.00% 99.09% 0.91% 0.00% 0.00%

Large Blend Category Avg 1.89% 94.48% 3.19% 0.28% 0.16%

Source: Morningstar Direct

Market Cap, 3/31/17 Giant Large Medium Small Micro

50.01% 36.55% 13.37% 0.08% 0.00%

Large Blend Category Avg 67.77% 13.47% 16.25% 2.28% 0.23%

Source: Morningstar Direct

Swan Global Investments | 970-382-8901 | swanglobalinvestments.com

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Valuations, 3/31/17 Price/Prospective Earnings Price/Book Price/Sales Price/Cash Flow Dividend Yield

Swan DRS (%net) 21.26

S&P 500 21.26

Large Blend Category Avg 22.19

2.86 1.93 12.19 2.33%

2.98 2.09 13.13 2.13%

3.10 2.18 13.56 2.29%

Source: Morningstar Direct

Given the fact that typically 85% to 90% of the portfolio is held in S&P Select Sector ETFs, these numbers are completely logical. The strategy does, however, pursue more of an equal-weight sector approach to the market. The S&P 500 is a market capitalization-weighted index. The equal-weight sector approach leads to a bit of a tilt to both smaller names and value characteristics, which you see in the market cap and valuation tables, respectively. If one is a proponent of Fama-French and the belief that there is a systematic value premium and a small cap premium, the equal-weighted sector approach is a way to emphasize those factors. But there is little doubt that the portfolio characteristics of the DRS are large cap, core equity. On the other hand, you will certainly see a difference of returns between the DRS and the S&P 500 index or the typical large blend mutual fund. If one were to look at traditional “tracking” metrics like correlation and R-squared, you will see much higher levels of dispersion from the S&P 500 than you would with a traditional large cap core fund. Metrics, 3/31/17

Beta

RSquared 22.08%

Correlation

0.30

Tracking Error 13.61%

Swan Defined Risk Strategy (net) Morningstar Large Blend Category S&P 500

0.47

Up Capture 52.1%

Down Capture 13.0%

0.98

1.57%

98.94%

0.99

94.4%

102.6%

1.00

0.00%

100.00%

1.00

100.0%

100.