The best of strategies for the worst of times: Can portfolios be crisis proofed?

In the late stages of long bull markets, a popular question arises: What steps can an investor take to mitigate the impact of the inevitable large equity correction? Hedging equity portfolios is notoriously difficult and expensive. In this article, the authors analyze the performance of different tools that investors could deploy. For example, continuously holding short-dated SP 500 put options is the most reliable defensive method but also the most costly strategy. Holding safe-haven US Treasury bonds produces a positive carry but may be an unreliable crisis-hedge strategy because the post-2000 negative bond–equity correlation is a historical rarity. Long gold and long credit protection portfolios sit between puts and bonds in terms of both cost and reliability. Dynamic strategies that performed well during past drawdowns include futures time-series momentum (which benefits from extended equity sell-offs) and a quality strategy that takes long (short) positions in the highest (lowest) quality company stocks (which benefits from a flight-to-quality effect during crises). The authors examine both large equity drawdowns and recessions. They also provide some out-of-sample evidence of the defensive performance of these strategies relative to an earlier, related article.

Duke Scholars

Author Campbell R. Harvey Fuqua School of Business