Global Dynamic Hedging
Investing in Dynamic Hedging & Trend Following
Dynamic hedging & trend following helps to determine when to stay invested, and when to exit an asset class with changing trend characteristics. As such, a disciplined and rule-based trend-following investing approach can serve as an effective portfolio insurance technique.
The purpose of Global Dynamic Hedging (DynaHedge) is to remain fully invested in a diversified international portfolio as long as its different components remain in a positive trend. When the positive trend of a specific asset class (or a specific element of an asset class) is invalidated, the allocation is reduced and when a bear trend is established, the allocation is suppressed. In asset classes producing no expected cash flow, a bear signal may also translate into a short position.
Recent history showed that holding a diversified portfolio is a necessary but sometimes insufficient condition for success.
In 2018 and even more so so in 2022 so far, an internationally diversified portfolio invested in stocks, bonds, and precious metals delivered a double-digit negative total return in most cases. Bonds did not hedge stocks. Neither did precious metals. Credit spreads widened and government bonds underperformed as well. This is because, in times of stress associated with global deleveraging (itself associated with monetary tightening, normalizing monetary policies, or an exogenous shock), the correlation between stocks, bonds, and precious metals can significantly increase, defeating the purpose of diversification.
In 2020, key levels were breached on the way down and then on the recovery path that a rigorous application of trend-following signals helped to navigate.
Natural portfolio hedges such as government bonds lost much of their efficiency as shock absorbers because their medium to long-term expected return (yield to maturity) was reduced to zero or even negative nominal yields before the 2022 reckoning year.
Driving a car with broken shock absorbers is much more dangerous than generally believed as they provide a false sense of security in good times and will fail you in bad times. This is exactly what happened in 2022.
An investment in Dynamic Hedging and Trend Following aims at addressing these shortcomings.
The portfolio is invested in an internationally diversified portfolio of equities distributed across the US, Europe, Asia, and EM markets. It will also be invested with allocations to precious metals, bonds, and commodities.
When the positive trend in a given asset class is invalidated, a signal is issued leading us to consider a reduction in the relevant portfolio weights, until a positive trend returns. In some cases, we may apply negative weights to certain portfolio elements exhibiting negative trend characteristics.
In order to avoid some of the pitfalls of automatic trading (false signals) and in certain circumstances (when the breach is not clear), we will apply some judgment before triggering the signals so as to determine if and when an asset or asset class's trend is clearly broken.
The portfolio seeks further diversification with a weight on currency investing.