Understanding Equity Hedges


2019 is fast becoming a year of extremes. After the best start to the year in decades, U.S. equities experienced one of their worst Mays on record. While stocks have subsequently bounced, the damage to risky assets lingers.

The Nasdaq Composite and Russell 2000 indexes flirted with correction territory, down 10%, while semiconductor stocks approached bear market territory, down 20%.

Given the sudden shifts in the market, investors are once again exploring how to best hedge equity risk.

The challenge is that not all hedges work in all circumstances. For example, what helps insulate a portfolio against higher inflation is not the same as what you’d want to own if you were worried about a recession.

The good news today, to the extent there is any, is that investors know what they’re trying to hedge: a trade-induced slowdown. And if a slowing economy is the proximate danger, history suggests three, fairly reliable portfolio hedges: duration, gold and the yen.

Lessons from history

My colleague Paul de Vassal examined S&P 500 drawdowns of 10% or more going back to the late 1990s. What he found was that the traditional “risk-off” hedges generally worked, albeit to varying degrees.

Drawdowns Hedge Performance

The most obvious and traditional hedge — U.S. Treasuries — gained an average of about 2% when equity markets corrected. Investors can do better by buying longer-duration Treasuries, but obviously at the cost of more risk (see Chart 1). Outside of duration, two other classic hedges also performed in a similar manner. Both gold and the yen also gained about 2% when equity markets were faltering.

The gold results are consistent with what I’ve discussed in previous blogs: Gold works best when volatility is spiking. Since 1990, in months when volatility was rising gold beat the S&P 500 by an average of 30 basis points (bps, or 0.30%). When volatility really spikes, defined as a monthly advance of more than 20% in the VIX Index, gold beats the S&P 500 by 5% on average.

The third hedge, the yen, is the least obvious. Why would owning Japan’s currency help insulate a portfolio? Part of the rationale lies in the yen’s role in carry strategies, i.e. borrowing in a cheap currency to fund better yielding assets. Historically, these strategies tend to unwind when volatility rises, which means investors need to buy back yen. As a result, as with Treasuries, the yen has had a consistently negative correlation with stocks since the early 2000’s.

Bottom Line

The bottom line for investors is that in an environment in which softening growth is the big threat, there are hedges that have worked relatively well during the past 20 years. For investors looking to maintain equity exposure but also manage risk, a combination of these three should help insulate a portfolio if things turn more interesting.

Russ Koesterich, CFA, is Portfolio Manager for BlackRock’s Global Allocation team and is a regular contributor to The Blog.


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Could a Fed Rate Cut Be Bearish?

Bbg Rate Cut Prob

After the S&P 500 suffered one of its worst May’s in decades, stocks are rallying so far in June on expectations the Federal Reserve is about to cut interest rates. The next Federal Reserve Open Market Committee meeting is set for June 19, 2019. Based on the Bloomberg World Interest Rate Probability screen (WIRP), markets are pricing in a 20% chance for a rate cut next week, an 84% chance in July, and a more than 94% chance of a rate cut in September.

Beware the Fed Pause and Reverse.

Should investors expect a new equity bull market after a rate cut? We looked at past interest rate cycles most like the current environment, periods when the Federal Reserve began a series of interest rate increases over multiple quarters, paused for multiple quarters, then began a series of rate cuts. It turns out this kind of “pause and reverse” from the Fed is quite rare. Since 1972 there have only been two similar periods. The forward 3, 6 and 12 month returns for the S&P 500 were negative each time.

Fed Pause Reverse

Maybe It’s Different This Time. Maybe Not.

Markets have faced a similar environment only twice in the past 47 years, both resulting in recession and costly bear markets. Two examples are certainly not a large sample size, and of course it could be different this time. But investors expecting a Fed rate cut to automatically result in higher equity prices may be headed for disappointment. A Fed “pause and reverse” may indicate it’s time for advisors to be sure they have a solution for risk management in their asset allocation.


For more than twenty years, Anchor Capital has been at the forefront of risk-managed investment strategies designed to help advisors and their clients be more confident in reaching their goals. Anchor Capital is a SEC-registered investment adviser located in Aliso Viejo, CA with over $800M in assets under management. Our investment team has a combined 40 years of experience in the research and execution of quantitative trading disciplines, risk management, and alternative investment strategies.