Exchange traded fund investors seeking to diversify their investment portfolios may consider a brand new approach that simply and elegantly reinforces their core equity exposure.
In the recent webcast, Adding Convexity To Your Core Equity Portfolio, Paul Kim, CEO and Co-Founder, Simplify; David Berns, CIO and Co-Founder, Simplify; Corey Hoffstein, Co-Founder and Chief Investment Officer, Newfound Research, highlighted their own suite of ETF strategies that help protect a portfolio in this new near-zero rate environment that poses a greater risk to traditional diversification through fixed-income assets.
The strategists pointed out that today’s stock markets look pricey with heightened equity valuations, and protection via bonds now comes with greater risks since interest rates are already hovering around record lows. Investors have traditionally incorporated bonds into a balanced portfolio to help de-risk or mitigate the volatility from their equity exposure. However, this bond de-risk component is no longer sufficient due to the opportunity cost of holding bonds in a low-yield environment.
On the other hand, the strategists argued that put options may be an alternative avenue for investors to mitigate risk while maintaining their long exposure to the stock markets. Specifically, Simplify’s downside protection strategy includes a 98% beta exposure to the S&P 500 Index and a 2% put option overlay that includes modest and present annual option budget, deep out of the money strikes, focus on two common types of market dislocations and sensitivity of options payoffs. The strategy comes with quarterly dividends through a tax-efficient and cost-effective ETF wrapper.
“In addition to diversifying across assets, investors should also diversify across how they manage risk,” according to the Simplify strategists.
The strategists pointed out that various correlation-based and direct hedges come with certain risks. For instance, long-term Treasuries are not effective in periods of rising interest rates, trend-following strategies are not as effective in reversal markets, alternative risk premia is less effective during coincidental drawdowns, and direct hedges don’t work as well in a shallow decline.
Looking ahead, the strategists also argue that there is an increasing probability of greater equity moves higher since inflation is a boon for nominal earnings and multiples have room to run with yield curve control from the Federal Reserve. They highlighted market supports such as central bank policy and narrative economics, the increasing role of “indexed” basket trading, and growing scope of volatility-contingent strategies.
To capitalize on further upside potential, Simplify has deployed deep out of the money calls. Specifically, Simplify’s upside strategy includes a 98% beta exposure to the S&P 500 and 2% call option overlay with modest and preset annual option budget, deep OTM strikes, focus on one type of market dislocation and robust to path dependency inherit in options.
Simplify has recently come out with a suite of so-called PLUS Convexity ETFs, including the Simplify US Equity PLUS Convexity ETF (SPYC), Simplify US Equity PLUS Downside Convexity ETF (SPD), and Simplify US Equity PLUS Upside Convexity ETF (SPUC).
The Simplify US Equity PLUS Convexity ETF is intended to boost equity performance during extreme market conditions, providing exposure to the S&P 500 with a Call/Put Overlay.
The Simplify US Equity PLUS Downside Convexity ETF is designed to boost equity performance during extreme drawdowns, providing exposure to the S&P 500 with a Put Overlay.
Lastly, the Simplify US Equity PLUS Upside Convexity ETF is intended to boost equity performance during extreme market rallies, providing exposure to the S&P 500 with a Call Overlay.
Financial advisors who are interested in learning more about core equity portfolio strategies can watch the webcast here on demand.