Practical Applications of Portfolio Protection? It’s a Long (Term) Story…

Abstract

In Portfolio Protection? It’s a Long (Term) Story…, from the February 2021 issue of The Journal of Portfolio Management, Nicholas McQuinn, Ashwin Thapar, and Dan Villalon (all of AQR Capital Management) discuss how best to mitigate losses and preserve returns during lengthy bear markets. They compare the historical efficacy of a variety of approaches to drawdown mitigation, including put-option hedging and several hypothetical alternative approaches such as defensive equity investing, risk parity, alternative risk premia, and trend following.

Though the authors compare results for drawdown of varying length, they argue that “slow crashes” (e.g., grinding bear markets exceeding a year) are greater hazards to long-term wealth accumulation than “fast crashes”—shorter if possibly more unsettling market downdrafts lasting up to a year. While option strategies can be quite effective at buttressing portfolio value during fast crashes, this protection tends to diminish during prolonged bear markets. The authors argue that diversification is a better approach than options to protect against long-term down markets.