investment viewpoints

Multi-asset and managing downside risk

Multi-asset and managing downside risk
Alain Forclaz - Deputy CIO, Multi Asset

Alain Forclaz

Deputy CIO, Multi Asset

Berkshire Hathaway’s Warren Buffett famously described his investment rules as “Rule no. 1: Never lose money.  Rule No. 2: Never forget rule No.1.” 

Such caution relative to downside risks is particularly apt for those on the lookout for convexity and the resilience it brings to a portfolio.  Bearing in mind that convexity-driven investors also seek to capture upside participation, we consider solutions that are specifically-tailored to this conundrum.

Dynamic drawdown management (DDM) could prove particularly adept at helping reduce downside risk at a reasonable cost, in our view.  Our proprietary DDM process looks at four key components – realized drawdowns, risk appetite, robustness and relative drawdown – to determine how to best deploy risk. 

We believe taking into account these components improves portfolio efficiency, while addressing some of the pitfalls of option-based strategies. DDM is our go-to tool to manage downside risk to any portfolio1, not simply equities, such as this example.

As convexity normally comes at a price, careful design is crucial. We review a number strategies and asset classes with appealing asymmetry properties. Some focus on seeking to profit for large market moves (including, in particular, on the downside) such as long volatility strategies. Some target asymmetric returns, such as convertible bonds. Finally crossover credit is relevant in this context in seeking to reduce the negative convexity inherent in bond prices. In summary, through precise design, we seek to embed convexity into our portfolios in a cost-effective manner.

As investors continue to focus on downside risks, we believe a multi-asset approach is well-adapted to helping them follow Buffett’s two rules. Featuring a simple, straightforward structure, we propose a portfolio demonstrating how investors might optimize their approach to achieving stable, long-term returns.

Please find key terms in the glossary.


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1 Please see LOIM paper entitled: Rethink your core portfolio using multi-asset.

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