7 October 2020, 00:06AM UTC

Chief Investment Office GWM

Investment Research

A guide to portfolio hedging

Derivatives Strategy

Luca Henzen, Analyst, UBS Switzerland AG

Moritz Vontobel, Analyst, UBS Switzerland AG
Dirk Effenberger, Head Investment Risk, Chief Investment Office GWM, UBS Switzerland AG

• Recent history shows that stock market crashes and bear markets happen
on a fairly regular basis. Equity drawdowns can quickly wipe out years of
gains, but thanks to hedging investors can mitigate these losses.
• Various instruments and asset classes have provided good protection
in past market corrections. However, reliable hedging strategies, that
constantly offset equity losses, are difficult to implement and often their
costs can impair the return potential of a portfolio.
• In this report, we define a stylized framework to compare different
Source: Getty
protection strategies and highlight key characteristics of hedging
instruments. Our methodology provides a tool to investors to reduce
hedging costs, improve protection and lower the risk of unexpected
portfolio losses during times of market stress.
• With the current ultra-low yields, government bonds are no longer
likely to be as effective hedges as in previous years. Investors looking
for portfolio protection should therefore consider a diversified hedging
strategy based on a combination of proxy hedges and option structures.

In 2020, financial markets sent investors a clear reminder that large equity
drawdowns can happen. The longest expansionary cycle in modern history,
which started after the financial crisis of 2008-09, ended abruptly when fears
about the COVID-19 pandemic escalated. In March, several countries were
forced to introduce strict lockdown measures to slow the spread of the virus.
The outcome was a rapid decline of economic activity and a broad equity
market sell-off. Safe-haven assets such as government bonds or precious
metals were initially under pressure due to investors' forced-selling activities,
questioning their effectiveness as portfolio diversifiers. Volatility spiked to
levels last seen when Lehman declared bankruptcy in 2008.

In our view, hedging must play a critical role in portfolio construction. A

solid hedging strategy can improve the stability of a portfolio, as it typically
reduces drawdowns, shortens the recovery time and ultimately gives the
freedom to add risk during market recoveries. In this report, we provide an
easy-to-apply way to evaluate and compare hedging solutions. We introduce
a scorecard based on effective metrics to measure the efficiency, reliability

This report has been prepared by UBS Switzerland AG. Please see important disclaimers and disclosures at the end of
the document.

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Derivatives Strategy

and costs of various hedging instruments. We first look at proxy hedges

such as government bonds, safe-haven currencies and gold, and then turn
to protection strategies based on derivatives. The goal is to give investors a
tool to better understand the characteristics of various hedging instruments
and to select the most suitable hedging strategy based on their needs and
expectations.

The report should be considered as a broad study on portfolio hedging. For

a deeper analysis on derivative-based protection strategies, we highlight the
publication "Hedging guidebook" from 9 April 2019.

Portfolio sensitivity to market drawdown

With falling interest rates, investors have increasingly embraced riskier assets
in their hunt for positive returns. The shift to more speculative assets involves
a higher risk of experiencing losses. Although increasingly central banks'
interventionism indirectly supports financial markets, market downturns
remain unavoidable. Equity setbacks in excess of 10% can easily erase gains
accumulated over years and force investors to adjust their investment strategy
in a suboptimal way. Often in times of heightened market volatility, trading
activity declines and asset liquidity deteriorates.

In the past 20 years, large equity corrections have been a recurring theme
(see Fig. 1). Reducing the sensitivity of a portfolio to such drawdowns would
directly translate into lower volatility, a higher Sharpe ratio and ultimately
potentially better long-term returns.

Figure 1 - Historical drawdowns of global equities and a

balanced portfolio
Grey periods indicate equity drawdowns worse than 10%. As bond and equity proxy, the
Bloomberg Barclays Global-Aggregate index and the MSCI World index, both in USD, have
been used. The 60/40 portfolio is monthly rebalanced.

Source: Bloomberg, UBS, as of 30 September 2020

Given their attractive return potential, stocks remain the main contributors
to return and risk in most portfolios. Diversifying the exposure, including

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uncorrelated assets classes, helps mitigate some equity risk. Investors forgo
some higher expected returns from risky assets like stocks in return for lower
portfolio volatility and lower drawdown sensitivity. Designing a well-balanced
portfolio is increasingly challenging and perfect diversification is difficult to
obtain. Correlation is not constant and often rises exactly when investors
need it, as different investments become more correlated during market
stress. Moreover, low correlation does not mean negative correlation. Fig.
1 clearly shows that even a balanced portfolio composed by uncorrelated
asset classes such as global equities and bonds incurred significant losses in
past market downturns. Diversification helped to reduce the overall portfolio
drawdown, but the bond appreciation was not enough to fully compensate
the losses in equities.

A thoughtful hedging strategy can help fill the gap left by diversification by
significantly reducing portfolio vulnerability in volatile markets. Hedges are
instruments or asset classes that are inversely correlated with equities (see
Fig. 2). They increase their value during episodes of market stress, ultimately
offsetting part of the equity losses. While counter-cyclical assets such as safe-
haven currencies or government bonds typically show negative correlation to
stock markets, derivative securities can provide strong negative correlation to
equities, as they allow building short exposure to the underlying asset.

Figure 2 - Sensitivity to equity drawdowns

Source: UBS, as of 30 September 2020

Similar to diversification, adding a hedge to a portfolio may reduce the return

of a portfolio. Hedging typically involves paying a price, which in some cases
can affect the return objectives of an investment strategy. Understanding
the major characteristics of a hedging instrument and identifying the correct
timing when and how to apply it is therefore of paramount importance.

When is protection needed?

Due to its inherent costs, hedging over the longer-run risks impairing the
return objectives of an investment strategy and should therefore be used only
in specific cases. In general, the introduction of a protection strategy should
be triggered when the risk tolerance of an investor is not aligned with the
risk-return profile of the portfolio. This usually occurs when:

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• Market conditions deteriorate with an increase in asset volatility. In turn,

the risk of a portfolio exceeds the investor's expectation.
• The indirect exposure of a portfolio to single risk factors (e.g. USD
strength, emerging market recovery, oil price, etc.) changes and the
concentration to one factor becomes too dominant.
• The probability of a negative event rises significantly. This does not strictly
correspond to a change of the investor's baseline scenario. A simple
shift of the probability distribution can already justify a more cautious
investment approach, especially if the investor sees a higher risk of an
unfavorable development than the market is accounting for.
• The value of an investment portfolio cannot be lower than a certain
threshold level e.g. total liabilities, planned expenses. Should the portfolio
value approach this limit, as alternative to an outright reduction of risks,
hedging may be introduced to avoid breaching this limit.

Hedging scorecard
By purchasing a hedging instrument, the investor is willing to pay or to
allocate a part of the portfolio to an instrument that ideally provides sufficient
positive returns during times of market distress. Ultimately, this should
compensate for the negative performance of the rest of the portfolio without
being a significant drag on performance during periods of market calm. But
how to compare different hedging instruments? Which metric should we
apply to measure their qualities and ultimately assess their potential to protect
a portfolio in the next equity drawdown?

Traditional financial indicators like volatility or risk-adjusted returns are

not optimal in our view, as they cannot capture key characteristics of
hedging instruments such as correlation, sensitivity and cost. We therefore
developed a simple but effective hedging scorecard based on three metrics.
These metrics help us identify strengths and weaknesses of each hedging
instrument and should be carefully evaluated by investors who are looking
for a protection strategy:
1. Sensitivity: Ideally a hedging instrument generates very large positive
returns when equity markets fall. We therefore compute sensitivity as
the realized return of the instrument during a risk-off event divided
by the drawdown in global equities. A high sensitivity means that the
instrument provides effective protection, as it is able to compensate for
the losses in equities. As reference, a value of one would correspond to
a perfect hedge—i.e. one unit of the hedge instrument perfectly offsets
one unit of equities in that particular sell-off. The sensitivity score is the
average of the instrument sensitivity in past equity drawdowns (see
Table 1). As we will see later, a sensitivity score between 0.5 and 1 is
equivalent to a good hedging performance.
2. Costs: The ability to offset equity losses typically does not come for
free. As for the buyer of an insurance, who is asked to pay a premium
to protect against a specific event, hedging involves an opportunity
cost —e.g. direct cost or potential return forgone by holding it rather

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than equities. Ideally we would like to have a higher sensitivity at lower

costs (high convexity or bang for your buck), but often there is a positive
correlation between the two metrics. Hedging instruments that are very
sensitive usually cost more and can even become more costly during
market crises. As a proxy for hedging costs, we measure the average
monthly return of an instrument over the past 20 years excluding the
drawdown periods of Table 1. In our view, this value provides a fair
estimate of what investors would have paid for holding the asset in
their portfolios during periods of market calm. While a positive value
corresponds to higher costs, a negative value means that the instrument
would have generated a positive return on average.
3. Consistency: There are several potential causes for an equity sell-
off, implying different reactions of other asset classes. This is also true
for hedges. What worked well during one risk-off shock may not
provide the best protection during a different event. We therefore
define as consistency the reliability of a hedging instrument to protect
unconditionally. Instruments that in most of the selected sell-offs over
the past two decades were able to offset some part of the equity losses
(i.e. positive sensitivity), have a high consistency score approaching
100 percent. A score of 50% indicates that the instrument provided
protection in only half of the past equity corrections. Ultimately,
consistency captures the basis risk of a hedge, providing a fair
assessment of its reliability during previous crisis periods. Given their
ability to provide negative exposure to an asset, derivatives-based
hedging strategies typically have very-high-to-perfect consistency.

Figure 3 - Hedging scorecard

Source: UBS, as of 30 September 2020

We compute the three metrics of our scorecard using data starting in 2001.
A risk-off event is defined as a period during which global equities, proxied
with the MSCI World index in USD, fell more than 10%. Table 1 shows the

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selected periods and their duration. The full results of our analysis can be
found in the tables at the end of the document.

We decided to classify the instruments using sensitivity, costs, and consistency

to identify and highlight the key characteristics of hedging. As for the
decision to buy a new security or to overweight an asset class in a portfolio,
investors looking for protection should include in their selection process other
indicators such as valuation, fundamentals or long-term return expectations.

Table 1 - Global equity drawdowns in excess of 10%

Since 2001.

Source: Bloomberg, UBS, as of 30 September 2020

Hedging instruments
In this section we apply the hedging scorecard to different hedging
instruments. We classify hedges in two major categories: proxy hedges and
derivatives. Proxy hedging involves taking a position in assets that on average
show strong negative correlation to equities during risk-off events. With
respect to derivatives, we mainly focus on securities that provide negative
exposure to equities with a non-linear payoff at expiry. A vanilla put option
is the classic derivative contract used by investors to protect their equity
position. A put gives the buyer the right, but not the obligation, to sell the
underlying security at a predefined price.

Proxy hedging
Proxy hedging involves using a financial instrument that is negatively
correlated to a particular risk, in our case the risk of an equity sell-off.
Counter-cyclical assets can be considered as proxy hedges for risk assets, as
they typically increase their value in times of market turbulence. As opposed
to equities, these assets tend to be negatively correlated to the business cycle.
So-called safe-haven investments are assets with defensive characteristics
that clearly fall into this category. Typical examples are gold, cash and high-
quality government bonds. We classify these assets as proxy hedges as they
can proxy the payoff of an insurance.

Given the extent of this analysis, within proxy hedging we also investigate
solutions that provide negative exposure to pro-cyclical assets through a short

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position. A strong proxy hedging solution can indeed result from a long
position, or overweight, in a counter-cyclical asset and a short position, or
underweight, in a more cyclical asset. Buying a safe-haven currency versus
a cyclical currency is a typical example. Thanks to the hedging scorecard,
we are able to estimate their costs and understand their behavior in falling
markets. We selected the most common proxy hedging solutions that are
widely tradable. We decided to omit alternative asset classes, such as hedge
funds or real estate, due to their liquidity issues in market stress. In Fig.
4, we classified proxy hedges in each of the three metrics of our scoring
methodology. For a detailed view of the instruments' performance in past
equity sell-offs, please refer to the tables at the end of the document.

Figure 4 - Results of the sensitivity, costs and consistency

scores for major proxy hedges
The larger the circle, the higher the consistency score (i.e. higher reliability).

Source: UBS, as of 30 September 2020

Fixed income: History tells us that allocating part of a portfolio to high-

quality bonds increases diversification and improves the overall risk profile
of a portfolio. As we can see in Fig. 4, over the past 20 years, US Treasuries
and high grade USD bonds have scored extremely well in each metric of
our scorecard. Moreover, the longer the duration (e.g. 20y+ Treasuries), the
better the sensitivity in markets sell-offs. The very high hedging efficiency
of US Treasury bonds can be explained by the strong bull market of
sovereign bonds in recent decades and the constant decline of interest
rates. However, in 2020 central banks have further moved their reference
rates into negative or near-negative territory to support the post-pandemic
economic recovery. Investors are therefore questioning the room for
yields to move lower from the current low levels. Will bonds have enough
capacity to offset equity losses in the next downturn?

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Although low yields diminish the protective power of bonds, we still

believe that allocating part of a portfolio to government bonds can help
reduce portfolios sensitivity to market sell-offs. Nevertheless, investors should
remember that rates will eventually go up and bond prices can fall.
Consequently, the opportunity cost for holding bonds in a portfolio has
increased. With the risk of rising inflation investors may also experience a
loss of purchasing power in the long term. In such an environment, inflation-
linked bonds might be a valid alternative, albeit less efficient in sensitivity and
consistency according to our methodology.

Currencies: Beyond doubt, the US Dollar is the world's reserve currency.

The majority of international foreign exchange reserves held by central
banks are in USD. The USD is also the principal means of payment for
cross-border transactions. Over the past 20 years, the USD has kept its
safe-haven characteristic. Our analysis confirms that the currency tends to
appreciate against peers during global financial market stress. Although its
appreciation against pro-cyclical currencies in past equity drawdowns was
remarkable, holding USD in a portfolio also generated significant costs, in
particular against high-yielding currencies. But the rapid response of central
banks to support the post-pandemic economic recovery compressed the yield
differential.

Similar to the US Dollar, the Swiss franc and the Japanese yen are safe-
haven currencies that tend to appreciate during times of stress. While
the yen tends to strengthen when volatility rises mainly due to money
repatriation, the upward pressure that the franc faces is also a consequence
of the stability of the Swiss financial and political system. Over recent years,
however, both currencies have been a less than reliable hedge against market
turmoil. Negative interest rates, central banks' interventions and economic
relationships with China and the Eurozone have questioned the role of the
JPY and CHF as safe havens. That said, we believe that the two currencies
will remain safe-haven alternatives to the US dollar, in particular now that US
rates are so low.

Equities: Shares of companies that consistently pay dividends and have

stable earnings are usually regarded by markets as defensive. Because the
demand for their goods or services is not affected by the economic cycle,
they are able to weather weakening economic conditions. Although their
share price also comes under pressure during equity sell-offs, they typically
outperform the broader market when economic growth slows. Defensive
stocks typically belong to sectors as consumer staples, healthcare and utilities,
while energy, industrials or consumer discretionary stocks are considered as
cyclical. According to our methodology, a strategy that goes long defensive
versus cyclical sectors in the US market was able to protect fairly well
during past equity corrections. Similar results, would have been obtained
by a strategy that is long the Swiss equity markets—a healthcare and
consumer staples heavy market—versus the more cyclical Eurozone stock
market. Unfortunately, the relatively high hedging sensitivity of defensive
stocks comes at a high cost during calm or rising markets. Investing in
defensive stocks must therefore be diligently managed by investors to avoid
impacting long-term portfolio performance.

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Gold: The most prominent safe-haven asset is probably gold. Thanks to

its physical properties, gold is considered a reliable store of value and, on
numerous occasions, it has served as insurance against downturns in financial
markets. Although the "cheapest" hedge according to our scorecard—it has
generated a positive return on average over the past 20 years, gold scored
poorly in consistency. In the post-Lehman period of the GFC and in more
recent equity sell-offs, gold wasn't able to reliably protect against falling
equity markets. In risk-off events that are accompanied by liquidity shortages
such as in March 2020, gold even suffered significant losses, as investors
sold the asset to generate cash. Nevertheless, we believe that gold offers
value as a hedging instrument, in particular given the prevailing backdrop
of easy monetary policy and negative real interest rates. Other prominent
commodities such as silver, platinum, or copper did not show attractive
hedging characteristics, according to our analysis.

Derivatives
Option markets on major equity indices are generally very liquid and widely
used by investors. Thanks to their asymmetric payoff, index put options are
often used to insure a portfolio against adverse market movements. In our
analysis, we looked at the most popular option-based protection strategies.
We applied such strategies to major stock indices such as the S&P 500, the
Euro Stoxx 50 and the SMI. The US, Swiss and Eurozone stock markets are
largely represented in balanced portfolios, as they reflect a large portion of
global equities—more than 75% according to the MSCI World index. Their
option market is also fairly liquid.

Investors' preference for hedging equities through index options lifted the
price of out-of-the-money (OTM) put, i.e. puts with an exercise price (strike)
below the underlying asset's price at inception. Puts are usually more
expensive than OTM calls and often require a large downward move in the
underlying index to offset their cost. We therefore extended our analysis
to option structures that reduce cost of an OTM put by combining long
and short option positions. In particular, we looked at the following four
strategies:
• vanilla puts,
• put spreads,
• collars,
• put-spread collars.

While the costs for puts and put spreads are known from the beginning,
collar structures expose the buyer to unlimited losses, should the underlying
asset rise significantly. Collars and put-spreads collars are therefore suitable
for clients that believe the upside potential for markets is limited. Please
refer to the implementation box for further details regarding the four option
strategies.

Vanilla options are contracts that give the owner the right to buy or sell the
underlying asset at a specified price (the strike) on a specified date. The tenor
of the option, also called time-to-maturity, is a key parameter. Longer-term

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put options can protect over a longer horizon but have lower convexity at
inception (see also "Hedging guidebook" from 9 April 2019). Short-term
options offer higher convexity but need to be rolled more frequently. To see
how the tenor of an option affects the hedging characteristics, we used three-
month and one-year tenors.

Fig. 5 shows the sensitivity and costs of the various option-based hedging
strategies.

Figure 5 - Results of the sensitivity and costs scores for option-

based protection strategies
As each option strategy achieves the maximum consistency score, the circle size is the same.

Source: UBS, as of 30 September 2020

We omitted the consistency score, as all strategies achieved 100% reliability

(i.e. they always increased their value when equities sold-off). We present
the results of our hedging scorecard by comparing first the four option
structures, then the two tenors and last the three equity markets. For a
detailed view of the structures' performance in past equity sell-offs, please
refer to the tables at the end of this document.

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Structure: For obvious reasons, the most expensive derivative hedging

strategy is the outright long put. In each of the three indices, independently
of the tenor, puts score poorly on costs. Investors that are looking for a
cheap option-based hedge should therefore look at put spreads and put-
spread collars as an efficient way to mitigate expenses. A collar is the best
strategy according to the sensitivity score. The short call leg generates an
additional source of return in equity downturns that increases the overall
protection efficiency of collars. On the contrary, put spreads have low
sensitivity, given their limited protection band, with their protection limited
to the short put strike, which in our analysis corresponds to -15%. Overall,
the solutions with the highest convexity (i.e. sensitivity over costs) are put-
spread collars, followed by collars and put spreads.

Tenor: Across each structure and market, using short-term options generates
higher costs compared to longer tenors. This is consistent with the lower
average time-value decay of longer-term options. Sensitivity is higher in one-
year collars and puts, whereas for put spreads and put-spread collars the
three-month structures have higher sensitivity. In general, rolling longer-dated
options usually provides the best convexity, although it is associated with
higher trading costs due to the liquidity premium.

Underlying market: High-beta equity indices exhibit greater volatility than

the broader market and typically underperform in equity sell-offs. This
explains why, according to our analysis, option structures on the Euro Stoxx
50, a high-beta cyclical market, show the highest sensitivity score, regardless
of tenor and structure. In terms of costs, the situation is less uniform, as
other aspects play an important role. Level of implied volatility, skewness or
steepness of the term structure affect the cost of optionality. High levels of
implied volatility, which determines the cost of an option, translate into higher
costs for Euro Stoxx 50 strategies. This is particularly evident for outright
puts. Worth noting is that the elevated volatility skew of the S&P 500 makes
strategies that use put-spreads significantly cheaper compared to puts. In
general, the option strategies achieve the highest convexity when applied on
the Euro Stoxx 50 and the lowest convexity on the S&P 500, according to
our analysis.

Can one hedge "rule them all"?

As we have seen in the previous chapter, the perfect hedge does not exist.
Long-term US Treasuries scored strongly in our three metrics, but the current
ultra low yield challenges their effectiveness in the next market downturn.
Investors must therefore remember that the overall portfolio is often better
than its single parts. Although difficult to achieve and not free of charge,
diversification remains the first choice for investors to reduce risks in a
portfolio.

Hedging against market volatility involves paying a price. The cost is usually
higher when the protection is reliable and effective. The other way around,
cheap hedges are often less sensitive and may not work all the time. To
avoid potential disappointments, investors should therefore understand this
trade-off and carefully assess several hedging solutions before committing

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to a strategy. Often the combination of hedges can compensate for the

weaknesses of single instruments. A good approach is to apply diversification
alongside hedging. Instead of relying on one single hedge, investors should
split their protection across multiple hedging solutions, ideally with different
characteristics. As history and our analysis show, hedging due diligence is
very important—what appeared to be a good hedge in one downturn was
often less efficient in the following downturn.

Hedge to increase risk?

Interest rates are at historic lows. Over USD 17 trillion of global debt has a
negative yield as of September 2020. As a consequence of this low interest
rate environment, returns on more risky asset classes will be lower than in
the past.

Investors may need to increase allocation to risky assets, such as equities,

in order to meet their required return target. An investor with a classical
60/40 portfolio, with 60% allocated to equites and 40% to bonds, might
look to increase the equity allocation within her portfolio. A higher allocation
to equities will not only increase the expected return of the portfolio, but also
increase the risk of the portfolio.

While an increased equity allocation should achieve higher returns over the
medium- to long-term, the additional risks can be more challenging over
shorter time horizons. Especially in challenging market environments, such
as in March 2020, it may be demanding to remain invested and keep a high
equity allocation.

Increasing equity exposure, but simultaneously partially hedging it provides a

viable alternative. For example, an investor could choose an 80% exposure
to equities, of which she could hedge 50%. The hedged portion of the
equity allocation would achieve a lower return in upward trending markets,
as option premiums need to be spent in order to protect the equity portfolio.
But it will suffer less in adverse market environments.

Fig. 6 shows that such a strategy would have performed well over the
past five years. Partially hedging equity exposure would have put a drag
on performance during a strong bull market, as in 2016 and 2017. In
drawdowns, the hedged equity portion manages to reduce drawdowns.
In March 2020, the hedged equity portfolio would have reduced the
drawdown by almost 30% compared to an 80/20 portfolio. Over the
past five years, the hedged 80/20 portfolio has performed well and has
provided similar returns to an unhedged 80/20 portfolio, but with the
lower annualized volatility of a 60/40 portfolio. While these results provide
compelling risk adjusted returns, it remains important to acknowledge that
the hedged portfolio benefited from the steep drawdown in March 2020,
as the hedges typically perform very well in such a drawdown.

Such an approach could be of increased importance in the future. Not only

because investors need to increase allocation to risky assets to compensate
for reduced return expectations, but also because bonds may provide
less diversification with interest rates near zero. The long-term correlation

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between equity returns and bonds might provide some evidence. While a
one-year correlation has typically been negative, it has been positive for the
relationship between European equities and bonds over the past few years.
Interest rates in Europe have been very low for several years. If US equities and
bonds follow this pattern, diversification will most likely provide less benefit
than in the past.

Figure 6 - Hedged equity exposure performed well over the

past 5 years
Comparison of three portfolios investing in US equities and bonds. We use the S&P 500 as
an equity proxy and the Bloomberg Barclays US Aggregate as the bond proxy.

Source: Bloomberg, UBS, as of 30 September 2020

Note: The hedged portfolio uses 1 month 5% out-of-the money put options, rolled on a
monthly basis.

Conclusions
Diversification alone is not sufficient to protect a balanced portfolio from
severe market downturns. Specific hedging strategies should be considered
to reduce portfolio sensitivity to equity sell-offs. Over the past decades, high
quality government bonds proved to be the best hedging instrument, as
they provided strong negative correlation to equities in risk-off events, while
generating positive returns during periods of market calm. Given current
depressed yield levels and limited potential for interest rates to move lower,
investors should rethink if government bonds will offer the same level of
protection during the next market sell-off.

We presented an easy-to-apply methodology to assess the major

characteristics of hedging instruments. This analysis can be easily extended
to other protection strategies, as it highlights strengths and weaknesses
of different hedging solutions. Investors looking for portfolio protection
can therefore use our scoring methodology to compare different hedging
instruments and ultimately select their preferred strategy.

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Finding the best hedge for the next market downturn is challenging. Proxy
hedges can be relatively cheap, although their ability to protect is not
guaranteed. Option-based protection strategies may be used by investors
that need a higher degree of protection and are less sensitive to costs.
Furthermore, while the opportunity cost of a proxy hedge is not known in
advance, option strategies provide a certain degree of confidence regarding
costs and consistency.

In our view, the concept of diversification can be extended from traditional

portfolio construction to hedging. With the help of our scorecard, investors
can select the most suitable combination of hedging instruments optimized
for protection, reliability and costs.

Appendix
In the following tables, we provide a wider list of hedging candidates with
their return during the selected past equity drawdowns. In the last three
columns, we also show the score of the instrument or asset class in sensitivity,
costs and consistency. Historical data cover the period from 1 January 2001
to 30 September 2020.

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Start date Jan-01 May-01 Mar-02 Aug-02 Oct-07 May-08 Jan-09 Apr-10 May-11 Oct-11 Apr-12 May-15 Oct-15 Sep-18 Feb-20
Average
End date Mar-01 Sep-01 Jul-02 Oct-02 Mar-08 Oct-08 Mar-09 Jun-10 Sep-11 Nov-11 Jun-12 Sep-15 Feb-16 Dec-18 Mar-20 Sensitivity Costs Consistency
return
Length in weeks 8 18 20 6 23 23 9 6 21 4 5 19 16 13 5
MSCI World in USD -15.6% -25.9% -23.0% -14.6% -16.0% -44.0% -26.3% -13.5% -21.2% -12.5% -11.2% -11.8% -12.9% -16.6% -32.1% -19.8%
Bonds vs Equities 17.4% 39.3% 38.9% 18.0% 28.1% 54.5% 25.7% 11.7% 24.5% 9.7% 11.0% 9.6% 15.4% 17.9% 36.5% 23.9% 1.2 2.0% 100%
UST 7-10y 2.5% 5.3% 8.1% 3.7% 11.0% 1.2% -2.3% 5.0% 13.3% 2.7% 3.7% 0.6% 3.2% 2.3% 4.5% 4.3% 0.2 -0.1% 93%
UST 1-3y 0.9% 2.6% 3.0% 0.6% 3.9% 1.4% -0.3% 0.9% 0.8% 0.1% 0.0% 0.1% 0.1% 0.4% 1.8% 1.1% 0.1 0.0% 93%
UST 20y+ 3.6% 3.9% 7.7% 4.6% 11.6% 5.7% -9.6% 9.5% 31.9% 8.3% 11.2% 0.8% 7.2% 3.4% 8.5% 7.2% 0.4 -0.1% 93%
US TIPS 1-10y 2.0% 1.7% 6.7% 2.7% 9.4% -9.9% 1.1% 0.8% 3.1% 0.5% 0.5% -1.7% -0.1% -1.0% -3.3% 0.8% 0.1 -0.2% 67%
USD High Grade 2.6% 5.6% 7.7% 2.7% 6.4% -3.2% -1.5% 2.6% 5.2% -0.5% 0.8% 0.3% 1.1% 1.1% -1.6% 2.0% 0.1 -0.2% 73%
DXY 4.0% -3.0% -9.6% -0.3% -7.1% 18.7% 8.2% 8.5% 7.6% 6.2% 5.3% 3.4% -1.2% 2.9% 3.7% 3.1% 0.2 0.3% 67%
JPY vs USD -4.5% 6.0% 8.3% -2.9% 18.6% 10.8% -6.4% 2.3% 6.0% -2.4% 2.9% -1.1% 7.2% 1.2% -1.1% 3.0% 0.2 0.1% 60%
CHF vs USD -3.6% 11.5% 15.6% 1.5% 18.8% -9.1% -6.5% -7.6% -4.4% -7.1% -6.2% -6.7% -0.1% -3.7% -0.5% -0.5% -0.1 -0.4% 27%
USD vs EUR 4.7% -2.5% -10.7% -0.4% -6.4% 25.3% 10.3% 11.9% 9.8% 6.9% 6.7% 2.4% -1.9% 4.0% 1.5% 4.1% 0.2 0.2% 67%
USD vs GBP 2.9% 0.0% -8.5% -2.7% 4.6% 25.0% 3.4% 6.4% 8.3% 4.5% 5.9% 3.8% 5.8% 4.1% 12.3% 5.1% 0.3 0.1% 87%
USD vs CAD 4.8% 3.8% 0.7% 2.6% 7.2% 29.8% 7.1% 6.4% 8.9% 5.6% 6.2% 11.2% 5.4% 6.0% 8.5% 7.6% 0.4 0.4% 100%
USD vs SEK 8.2% 7.6% -8.6% -1.7% -3.2% 34.7% 19.8% 12.3% 14.9% 9.8% 8.0% 2.9% -1.0% 3.5% 7.0% 7.6% 0.4 0.3% 73%
USD vs NOK 3.1% -3.3% -12.2% -2.2% -1.1% 41.2% 2.7% 12.0% 11.5% 9.2% 7.0% 16.8% 2.8% 8.3% 26.7% 8.2% 0.4 0.3% 73%
USD vs AUD 10.5% 10.7% -1.8% -0.4% 2.1% 55.8% 11.3% 12.7% 12.3% 10.2% 8.0% 14.5% 1.7% 4.2% 16.2% 11.2% 0.5 0.7% 87%
USD vs NZD 5.6% 7.8% -6.2% -2.5% -0.1% 41.2% 16.9% 7.0% 4.4% 10.9% 9.1% 17.2% 2.1% 0.1% 13.1% 8.4% 0.4 0.6% 80%
CHF vs EUR 0.2% 7.4% 2.5% 0.9% 9.2% 12.1% 2.9% 3.3% 4.9% -0.8% 0.0% -4.6% -2.2% -0.5% 0.8% 2.4% 0.1 -0.1% 73%
Short EM Currencies (vs USD) 2.2% -0.7% -4.0% 0.0% -6.8% 17.0% 8.6% 6.2% 10.6% 5.8% 6.4% 10.0% 4.1% -1.0% 8.6% 4.5% 0.2 0.8% 73%
MSCI DM vs MSCI EM -1.4% -0.4% -9.5% -4.6% 1.3% 41.9% -12.1% -3.4% 8.6% 0.9% 1.0% 15.0% 5.9% -8.4% -5.9% 1.9% 0.1 0.5% 47%
MSCI CH vs MSCI EMU -1.4% 4.1% 12.5% 7.3% -1.4% 24.3% 5.4% 2.8% 12.0% 6.5% 4.1% 5.0% 5.2% 7.5% 16.6% 7.4% 0.3 0.5% 87%
MSCI USA Defensive vs Cyclical 9.9% 23.7% 6.1% 10.5% 8.6% 18.6% 14.5% 3.1% 5.5% 3.7% 5.7% -3.3% 7.3% 8.7% 6.3% 8.6% 0.4 0.8% 93%
Gold -0.3% 1.4% 4.8% 5.0% 22.6% -18.6% 7.3% 5.4% 5.9% -3.4% -2.3% -6.4% 6.3% 4.7% -5.4% 1.8% 0.1 -1.0% 60%
Silver -9.5% 0.3% 2.4% 1.4% 25.0% -44.8% 15.6% -4.8% -35.0% -11.5% -8.8% -13.7% -0.5% 2.4% -28.9% -7.3% -0.3 -1.9% 40%
Platinum -7.6% -19.4% 4.6% 3.2% 40.9% -62.4% 14.0% -12.4% -13.7% -7.2% -9.0% -18.8% -4.4% -4.2% -35.8% -8.8% -0.4 -1.5% 27%
Precious Metals -3.3% 1.3% 4.2% 4.1% 21.4% -26.8% 9.4% 2.7% -8.5% -5.5% -4.2% -8.9% 4.7% 4.2% -11.3% -1.1% 0.0 -1.2% 53%

Sensitivity: The average ratio of the asset return and the drawdown of global equities. Costs: A positive value indicates a negative average monthly return during calm periods. while a negative value means
a positive average monthly return. Consistency: The hit ratio of the asset with respect of positive return in the equity drawdowns.
Note: We used the following indices as proxy for the related asset classes on a total return base: the MSCI USA Cyclical Sectors-Defensive Sectors return spread USD index for MSCI USA Defensive vs
Cyclical, the JPM ELMI Plus Composite index for EM currencies versus the US Dollar, the Bloomberg Barclays Global Aggregate index in USD as proxy for global bonds, the Bloomberg Subindices for the
selected commodities.

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Derivatives Strategy

Start date Jan-01 May-01 Mar-02 Aug-02 Oct-07 May-08 Jan-09 Apr-10 May-11 Oct-11 Apr-12 May-15 Oct-15 Sep-18 Feb-20
Average
End date Mar-01 Sep-01 Jul-02 Oct-02 Mar-08 Oct-08 Mar-09 Jun-10 Sep-11 Nov-11 Jun-12 Sep-15 Feb-16 Dec-18 Mar-20 Sensitivity Costs Consistency
return
Length in weeks 8 18 20 6 23 23 9 6 21 4 5 19 16 13 5
MSCI World in USD -15.6% -25.9% -23.0% -14.6% -16.0% -44.0% -26.3% -13.5% -21.2% -12.5% -11.2% -11.8% -12.9% -16.6% -32.1% -19.8%
Bonds vs Equities 17.4% 39.3% 38.9% 18.0% 28.1% 54.5% 25.7% 11.7% 24.5% 9.7% 11.0% 9.6% 15.4% 17.9% 36.5% 23.9% 1.2 2.0% 100%
S&P 500 3M Put 6.2% 13.1% 13.3% 6.0% 0.7% 24.0% 9.2% 3.1% 6.0% 2.0% 2.3% 1.1% 1.5% 6.1% 21.4% 7.7% 0.3 1.0% 100%
S&P 500 3M Collar 7.2% 16.2% 16.4% 12.4% 3.1% 27.9% 20.0% 3.9% 8.6% 4.2% 2.8% 1.2% 2.4% 6.8% 24.3% 10.5% 0.5 0.9% 100%
S&P 500 3M PS 4.5% 7.6% 8.6% 4.7% 1.9% 10.5% 5.6% 2.4% 5.1% 1.4% 1.9% 1.1% 1.9% 5.0% 8.5% 4.7% 0.2 0.6% 100%
S&P 500 3M PS Collar 5.6% 10.7% 11.7% 11.0% 4.3% 14.3% 16.1% 3.2% 7.8% 3.5% 2.3% 1.3% 2.8% 5.7% 11.4% 7.4% 0.4 0.5% 100%
S&P 500 1Y Put 1.2% 9.9% 16.6% 9.6% 3.7% 28.9% 13.7% 4.2% 6.2% 5.0% 2.8% 1.7% 3.7% 6.7% 19.5% 8.9% 0.4 1.0% 100%
S&P 500 1Y Collar 2.3% 13.4% 19.3% 15.6% 6.1% 32.2% 22.2% 5.0% 8.9% 7.1% 3.3% 1.9% 4.6% 7.4% 22.3% 11.4% 0.5 0.9% 100%
S&P 500 1Y PS 0.5% 3.7% 7.7% 2.9% 2.2% 8.8% 1.9% 1.4% 2.3% 2.0% 1.1% 1.0% 2.1% 3.8% 6.4% 3.2% 0.2 0.4% 100%
S&P 500 1Y PS Collar 1.6% 6.9% 10.5% 9.0% 4.6% 12.3% 11.7% 2.2% 4.9% 4.2% 1.6% 1.2% 3.0% 4.5% 9.2% 5.8% 0.3 0.3% 100%
Euro Stoxx 50 3M Put 6.2% 24.4% 19.5% 11.6% 8.4% 25.7% 11.2% 3.8% 18.3% 2.8% 6.2% 2.3% 7.4% 3.0% 26.0% 11.8% 0.5 1.2% 100%
Euro Stoxx 50 3M Collar 7.9% 29.0% 25.9% 23.9% 13.1% 30.2% 22.4% 4.6% 23.2% 7.1% 7.3% 2.9% 12.0% 4.0% 29.1% 16.2% 0.8 1.0% 100%
Euro Stoxx 50 3M PS 4.8% 11.1% 8.9% 5.3% 7.3% 12.8% 6.8% 3.2% 8.8% 1.7% 4.4% 1.8% 4.9% 3.1% 10.3% 6.3% 0.3 0.6% 100%
Euro Stoxx 50 3M PS Collar 6.5% 15.5% 15.1% 17.4% 12.0% 17.1% 17.7% 4.1% 13.6% 5.8% 5.5% 2.5% 9.5% 4.1% 13.3% 10.6% 0.5 0.5% 100%
Euro Stoxx 50 1Y Put 1.3% 16.9% 21.7% 13.3% 11.1% 30.6% 15.5% 4.7% 21.5% 9.8% 5.8% 3.3% 11.9% 7.2% 24.3% 13.2% 0.6 1.1% 100%
Euro Stoxx 50 1Y Collar 3.0% 21.3% 27.2% 24.3% 15.7% 34.1% 24.4% 5.5% 26.0% 13.9% 6.9% 4.0% 16.6% 8.2% 27.3% 17.2% 0.9 0.9% 100%
Euro Stoxx 50 1Y PS 0.5% 4.8% 6.9% 2.3% 5.4% 6.9% 2.3% 1.5% 7.3% 2.7% 1.7% 1.5% 5.1% 4.8% 7.9% 4.1% 0.2 0.3% 100%
Euro Stoxx 50 1Y PS Collar 2.2% 9.0% 12.8% 13.9% 10.0% 10.9% 12.6% 2.4% 11.9% 6.7% 2.8% 2.2% 9.6% 5.7% 10.8% 8.2% 0.4 0.2% 100%
SMI 3M Put 8.1% 21.5% 15.2% 6.8% 7.8% 11.4% 8.8% 1.6% 8.4% 1.2% 1.7% 1.1% 4.8% 0.7% 14.0% 7.5% 0.4 0.9% 100%
SMI 3M Collar 8.8% 24.0% 17.6% 14.6% 12.3% 15.1% 14.5% 1.7% 9.6% 2.0% 1.8% 0.9% 6.6% 1.2% 15.5% 9.7% 0.5 0.8% 100%
SMI 3M PS 6.4% 10.4% 8.6% 4.0% 7.4% 5.8% 5.7% 1.5% 6.3% 0.9% 1.5% 1.0% 4.3% 0.6% 7.7% 4.8% 0.2 0.5% 100%
SMI 3M PS Collar 7.1% 12.9% 10.9% 11.7% 11.9% 9.4% 11.3% 1.6% 7.5% 1.7% 1.6% 0.8% 6.1% 1.2% 9.3% 7.0% 0.4 0.4% 100%
SMI 1Y Put 1.4% 15.9% 13.6% 9.0% 14.0% 19.5% 11.9% 2.0% 11.6% 4.8% 2.0% 1.6% 8.2% 2.9% 13.7% 8.8% 0.4 0.8% 100%
SMI 1Y Collar 2.1% 18.5% 15.6% 16.4% 18.4% 22.8% 16.2% 2.1% 12.8% 5.5% 2.1% 1.4% 10.0% 3.4% 15.2% 10.8% 0.5 0.8% 100%
SMI 1Y PS 0.7% 4.8% 5.7% 3.1% 6.9% 5.4% 2.1% 0.9% 6.0% 2.7% 1.1% 0.8% 3.9% 1.8% 4.7% 3.4% 0.2 0.3% 100%
SMI 1Y PS Collar 1.4% 7.2% 7.8% 10.7% 11.2% 8.8% 7.4% 1.0% 7.1% 3.4% 1.2% 0.6% 5.7% 2.3% 6.2% 5.5% 0.3 0.2% 100%

Sensitivity: The average ratio of the asset return and the drawdown of global equities. Costs: A positive value indicates a negative average monthly return during calm periods. while a negative
value means a positive average monthly return. Consistency: The hit ratio of the asset with respect of positive return in the equity drawdowns.
Note: The returns of option strategies have been computed using implied volatilities extracted from mid-prices of listed contracts. In the simulation, each option is held until its expiry date. We
used the Bloomberg Barclays global aggregate index in USD as proxy for global bonds.

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Derivatives Strategy

Appendix
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advisor about their own tax situation before investing in any securities.

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Derivatives Strategy

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