The Problem:
Yield is scarce and often comes with traditional asset class risks.
Our Solution:
Capture a Distinctive Yield Source
The Problem:
Yield is scarce and often comes with traditional asset class risks.
Our Solution:
Capture a Distinctive Yield Source
Stress tested – Varying outcomes across market environments
At Sagewood, we manage our Volatility Yield Strategy to isolate the Volatility Risk Premium, not to have a view on the near-term direction of the stock market.
All data contained in this material is based on a modeled strategy. For actual VYS performance please contact Sagewood.
In that respect, it aims to be a market neutral strategy, so the performance of the S&P 500 Index itself is not a driver of VYS results. This helps to explain why the Modeled Strategy has typically shown relatively low correlation to the S&P 500 and other traditional asset classes.
Traditional Asset Class Correlation with Modeled Strategy
October 2007 – June 2020
| Correlation to Model (Net of Fees) | |
| S&P 500 | 0.30 |
| Hedge Funds | 0.41 |
| Investment Grade Bonds | 0.01 |
| Commodities | 0.27 |
Source: Bloomberg – S&P 500 (SPX Index), Hedge Funds (HFRIFWI Index), Investment Grade Bonds (LBUSTRUU Index), Commodities (DJCI Index). For actual VYS correlation data please contact Sagewood.
Recent history has shown, however, that correlations have tended to converge in periods of market stress, just when portfolio diversification is needed most. From a portfolio construction standpoint, it is important to understand how the Modeled Strategy has performed in a variety of stock market environments.
The table below shows the relationship between S&P 500 monthly returns and Modeled Strategy performance over the past 12 years.
Modeled Strategy Avg Monthly Return in Various S&P 500 Return Environments
October 2007 — June 2020
S&P 500 Monthly Return
| S&P 500 Monthly Return | ||||||
| Down over 2% | -2% to -1% | -1% to 0% | 0% to 1% | 1% to 2% | 2% or Higher | |
| Number of Occurrences (total = 153) | 31 | 11 | 13 | 18 | 23 | 57 |
| % of Occurrences with Positive Modeled Strategy | 39% | 64% | 62% | 89% | 83% | 49% |
Source: Average Monthly Modeled Strategy Net Return calculated by averaging VYS model monthly returns within a given range of the S&P 500 Index. Bloomberg S&P 500 SPX Index (Monthly).
For actual VYS performance, pleae Contact Sagewood.
When the S&P 500 return has been flat to modestly higher (in the 0% to 2% range), Modeled Strategy has been positive over 85% of the time.
In the most challenging periods for the stock market, Modeled Strategy has posted positive outcomes less than 40% of the time.
These periods warrant a deeper look…
Outcomes During S&P 500 Index Drawdowns
Portfolio construction based on correlations is well established. The intent is to help manage overall portfolio return, with an emphasis on limiting downside risk.
Let’s look more deeply at Modeled Strategy net-of-fee results during the five largest S&P 500 Index drawdowns over the period from October 2007 through December 2019.
In the most challenging drawdowns for the S&P 500, Modeled Strategy results were sometimes flat, sometimes down, and even sometimes up – just what you’d expect from two assets with low correlation.
Modeled Strategy Net Returns During Largest S&P 500 Drawdown Periods
October 2007 – June 2020
Source: Bloomberg – S&P 500 (SPX Index).
The Financial Crisis:
In the 16-month drawdown of the financial crisis, when the S&P 500 Index dropped more than 50% cumulatively, Modeled Strategy returns net-of-fee were actually positive 2.3%.
Global GDP Growth Fears and the Downgrade of US Debt:
In the five months from May through September 2011, the S&P 500 Index fell 17% cumulatively. Modeled Strategy returns net-of-fee were down 1.5% over the same period.
Fed Raises Interest Rates:
From October 2018 through December 2018, the Federal Reserve raised rates twice. The S&P 500 Index fell almost 14%, with a rapid 10% decline in December alone. That precipitous move was especially challenging for the strategy, and Modeled Strategy net-of-fee returns ended the period down 3.5%.
The “Flash Crash”:
The S&P 500 Index fell more than 13% in two months from May through June 2010, triggered by the European Sovereign debt crisis. Modeled Strategy net-of-fee returns were down 43bps.
The China Crisis:
The S&P 500 Index fell 8.9% over the four months ending September 2015. The net-of-fee Modeled Strategy results were down just 5bps.
There are two takeaways from this assessment.
The Strategy is not immune to “shock risks” in the short term.
The Strategy has shown the diversifying benefit one looks for over some of the most extreme stock market downturns.
We believe the Strategy may offer strategic benefits that warrant its inclusion as an all-weather component of a portfolio.
So what does drive VYS results?
We can use the Financial Crisis (November 2007 – February 2009) to answer this question.
As VYS seeks market-neutral positioning, the strategy’s returns are not driven by whether the S&P 500 Index reaches a certain level in the future. Rather, VYS results are driven by the level of the VRP, and how quickly it changes. For example, a detailed review how the Modeled Strategy, the S&P 500 and the VRP performed during the Financial Crisis can help to clarify the difference.
The S&P 500 Index dropped more than 50% cumulatively from November 2007 through February 2009, while cumulative Modeled Strategy returns net-of-fee were positive 2.3%. However, the Financial Crisis actually comprises three very different VRP environments. Isolating each of them can help crystalize the key drivers of the Strategy’s results.
Phase 1 – November 2008 through early September 2008
The S&P 500 declined steeply while Modeled Strategy net results were positive. Over that same period the VRP average was positive, and forecast and actual volatility moved in a fairly narrow band.
*Phase 1 from 11/1/2007 through 9/8/2008
Phase 2 – early September 2008 through mid December 2008
Lehman Brothers filed for bankruptcy on September 15 and by December 16 the US Federal Reserve had dropped its benchmark rate to 0.25%. Over this unprecedented period, the VRP became extremely negative very quickly. Actual volatility leapt forward from 22 to 80 in only 24 trading days. Forecasts of volatility fell well short of actual. The rate of decline in the S&P 500 accelerated and Modeled Strategy results eroded in the face of the VRP headwinds.
*Phase 2 from 9/9/2008 through 12/15/2008
Phase 3 – mid December 2008 through February 2009
The VRP again moved rapidly, but this time in a positive direction before settling into a narrower positive band. The S&P 500 continued its descent. Modeled Strategy results, however, were positive as the VRP turned positive.
*Phase 3 from 12/16/2008 through 2/27/2009
In fact, over the peak-to-trough phase of the Financial Crisis, the Strategy was among the few gainers, along with Gold and longer-dated Treasuries.
A Leader Among Asset Classes in the Depths of the Financial Crisis
Cumulative Return by Asset Class During the Financial Crisis
Source: Bloomberg – S&P 500 (SPX Index), iShares IBOXX Investment Grade Corporates (LQD US Equity), Gold (GLD US Equity), iShares 7-10 Year Treasury Bonds (IEF US Equity). Modeled Strategy Performance is net of fees.
We can draw three conclusions from these market conditions and the resulting Strategy performance:
The Strategy opportunity set is greatest when the VRP is positive and moving in a fairly consistent band, as it did in Phase 1 of the Financial Crisis.
The Strategy can also benefit when the VRP is large and positive, even if it is changing rapidly, as it did in Phase 3 of the Financial Crisis.
The Strategy will face headwinds during those periods when realized volatility spikes very quickly, creating a negative VRP, as it did in Phase 2 of the Financial Crisis.
Have questions? Ready to talk?
Contact Sagewood at:
[email protected] or (212) 231-8770
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Meet the Sagewood Team
The team at Sagewood Asset Management offer a yield-oriented strategy in an overlay. Sagewood’s strategy aims to add yield to fixed income, equity, cash or diversified portfolios, without incurring the idiosyncratic risks of equities or fixed income.
