VIX Portfolio Hedging (VXH) Strategy 2013 Performance Review - InvestingChannel

VIX Portfolio Hedging (VXH) Strategy 2013 Performance Review

In 2013, being maximally long stocks was the only game in town, and investors who sought the safety of hedging strategies lagged unhedged indexes. As we noted before, 2013 was a difficult year for call writers, collar buyers, and any other investors who gave up some upside return potential in exchange for a little protection. It was an unusual year.

For some context, consider the drawdowns from peak annual equity that have been experienced by S&P 500 holders over the long term:

The maximum drawdown from peak equity in 2013 was 5.8%, with the longest time between a decline and full recovery at 35 days.

Historical odds do not favor a repeat performance for 2014, so investors looking to protect against large drawdowns will face the same choice as in any other year: which hedging strategies offer the best protection for the smallest cost? 

The popularity of volatility-linked products as hedging vehicles suggests that many investors still prefer volatility-based strategies over conventional alternatives. The key contribution of the VIX Portfolio Hedging (VXH) strategy that we developed in 2009 is that it offers long VIX exposure to hedge against large equity drawdowns at a lower cost than its peers, via:

  1. Dynamic allocation: VXH changes hedging allocations very quickly when needed. Allocations are updated daily, and during quiet periods in the market there can be many weeks when no change is indicated at all, reducing churn and transaction costs; but when the market changes its tone, the strategy is quick to respond.
  2. Asymmetric signal reduction: Some strategies treat volatility spikes symmetrically, but given the heavily skewed empirical distributions of volatility index and product returns (e.g. VXX), it makes sense to withdraw hedging capital at a faster rate than it is committed. VXH reverts to a lower allocation more quickly than it ratchets exposure higher in order to match the asymmetric nature of changes in equity volatility.

In the strategy review for 2012, we showed that VXH performs much better than a static allocation, and that relationship held true for 2013 as well. [chart]

More importantly, VXH again outperformed publicly listed tail risk ETPs. The strategy cost 1.3% versus an unhedged SPX index return, comparing favorably to VIXH (-8.5%), HUS.U (-9.1%), and VQT (-14%).

VXH strategy signals are available by subscription. Additionally, the strategy is offered for execution in separately managed accounts – contact us for more information at customerservice@investingchannel.com.

Jared Woodard is the publisher of the Condor Options Newsletter, VXH Portfolio Tracking, and Volatility Tracker Research Reports

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