Jeff Desjardins of Visual Capitalist published an online article in October, 2016 titled “9 black swan events that changed finance forever.”
Let’s examine 3 of these Black Swan Events to illustrate the benefit of a Black Swan hedge strategy on a conventional asset allocation portfolio.
The DOTCOM Crash of 2001. Leading tech giants placed large sell orders on their stocks at the market’s peak sparking a wave of panic selling. The NASDAQ lost 78% falling from 5046 to 1114. By the end of 2001, the bulk of the dotcom companies folded and trillions of dollars of investment capital vanished. The DOW drops 26.6%. The S&P drops 42.7%. Duration: March 11, 2000 to October 9, 2002.
How might a hedge strategy have reduced the loss. For illustration purposes, we’ll assume $100,000 is invested in the S&P. It would have lost $42,700. A cash hedge of 20% that captures 70% of the loss preserves $5,800 from loss. A 1x hedge (that goes up 1x for every dollar the S&P goes down) preserves $11,760. A 2x hedge preserves $17,400… and a 3x hedge preserves $23,200.
9/11/2001. The Twin Towers of the World Trade Center in New York City were hit by hijacked airliners. The first trading week after 9/11 saw the greatest losses in NYSE history. An estimated $1.4 Trillion was lost in 5 days. The DOW drops 14%. The S&P drops 11.6%. Duration: September 11, 2001 to October 25, 2001 for the S&P. It takes the DOW until November 13th to recover.
Using the same hedge assumptions, the loss incurred by $100,000 in the S&P would be $11,600. A 20% cash hedge catching 70% of the slide would preserve $1,624. A 1x hedge preserves $3,248. A 2x hedge preserves $4,872… and a 3x hedge preserves $6,496.
Global Financial Crisis of 2008. Lehman Brothers files for bankruptcy with $619 billion in debt. Bear Stearns collapses. The Sub-Prime induced crisis wipes out $10 Trillion in the global equity markets. The DOW drops 54%. The S&P drops 57%. Duration: 2007 to 2009. It took from October 9, 2007 to April 10, 2013 for the S&P to return to its 2007 high of 1,565.
$100,000 in the S&P would be down $57,000. A 20% cash hedge catching 70% of the slide would preserve $7,980. A 1x hedge would preserve $15,960. A 2x hedge preserves $23,940… and a 3x hedge preserves $31,920.
The good news in all these and other Black Swan market crashes is that given time… the market recovers. That’s good if you have lots of time and stay invested. It’s not so good if you don’t. We think it makes sense to manage money expecting the next Black Swan event. We know it’s coming… we just don’t know when. Connect with us and we’ll help you explore how to hedge your clients’ portfolios from the next Black Swan event.