Diversifying Diversification: Downside Risk Management with Portfolios of Insurance Securities

Abstract

Investors are always in search of diversifying securities and strategies to assist in downside risk management. The authors consider six popular diversifying securities: gold, Swiss franc, Japanese yen, bond futures, S&P 500 80% strike put options, and trend-following strategies. Using 50 years of data, the authors demonstrate that a portfolio approach to diversification strategies results in more robust outcomes when combined with a portfolio that has large equity exposure. Although each of the individual securities can be more or less beneficial in specific periods and environments, the authors conclude that a simple portfolio approach to diversification, whether optimized or not, allows investors to robustly manage risk while not being overly concentrated.

TOPICS: Portfolio construction, risk management, security analysis and valuation, currency, options

Key Findings

• ▪ Many securities and strategies, such as gold, yen, Swiss franc, bond futures, S&P 500 Index put options, and trend following, have all been used for downside risk mitigation.

• ▪ Over 50 years of history, each of these strategies assists in mitigating risk and improving the performance of a portfolio with S&P 500 exposure.

• ▪ However, by diversifying diversification (i.e., by combining these strategies), we demonstrate that more robust portfolio outcomes can be realized without the possibility of hindsight bias or over-reliance on one risk mitigation strategy.