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Would you play a game without a goalkeeper?

Caio Natividade
Sorin Ionescu

Even with the best strikers in the world on your team, you wouldn’t play without a goalkeeper – so why run a risk asset portfolio without an effective defensive overlay?

Widespread comparisons of the current situation with the Second World War and the Great Depression signal that we really are in the midst of a Black Swan moment.
To help investors limit the magnitude of negative outcomes now and prepare for similar crisis events in the future, the Quantitative Investment Solutions team has developed a framework called the ‘Defensive Strategy’ in which four components – Convexity, Carry, Certainty and Cycle (4 Cs, one in each corner of a diamond) – are used to evaluate strategies for use in investor portfolios:
  • Convexity – how much protection does a particular strategy provide in periods of market stress?
  • Carry - how much does the strategy ‘cost’ to maintain when markets are doing well?
  • Certainty – how confident can investors be that the strategy will deliver returns in periods of market stress, given that different stresses may have varying underlying drivers, and asset prices don’t react the same way across all downturns?
  • Cycle – how ‘sticky’ are the returns: does the strategy maintain the gains that it has accumulated during a market drawdown, or does it forfeit those returns as the market recovers?
This framework can be adapted to any portfolio composition, and the ‘efficiency parity’ method of combining strategies can also reference any asset mix. With the macro outlook still challenging and traditional hedges becoming more expensive, defensive portfolios should continue to help investors manage risk.
Even with the best strikers in the world on your team, you wouldn’t play without a goalkeeper – so why run a risk asset portfolio without an effective defensive overlay?
Caio Natividade, Head of QIS Research, has published a report in which he discusses the application of defensive overlay strategies to volatility-targeted portfolios, and how this can allow investors to redeploy capital to risk-seeking markets.
If you are a client of Deutsche Bank Research you can read the full report here otherwise please contact a Deutsche Bank sales representative,   
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