Skip to main content
Search

Effective protection strategies in uncertain times

Date: 16 May 2025

4 minute read

This week’s blog is written by portfolio manager Ian Jensen-Humphreys

Man using his laptop and a phone

Equity market participants seem to have consigned April’s tariff induced sell-off to the rear-view mirror – over the past few weeks, markets have rebounded strongly amid more benign news flow, resilient macroeconomic data, and solid company earnings.

This has given us some breathing space to review the portfolios’ positioning, in particular the risk mitigation or downside protection strategies. More specifically, we check whether the individual positions performed as we might have expected, and also if we still think they might work in the event of renewed volatility. After all, no two sell-offs are ever quite the same.

Generally, when it comes to managing risk on the downside, we are forced to make a key trade-off - confidence that the protection strategy will deliver, against the cost of holding the protection strategy.

How to minimise losses in a downturn

The easiest way to minimise losses in a downturn is to reduce your exposure from the start. This is the one strategy that will definitely work during a downturn. However, since markets generally rise over time, always having an underweight position can reduce long-term returns. Plus, it's very hard to predict exactly when markets will drop so you know when to reduce exposure.

Another way to reduce losses is to use "contractual hedges." These are strategies, such as equity “put” options, that could provide a payout if an equity index is below a certain level on the option's expiration date. They are similar to insurance contracts.

Alternatively, we can own other assets that we think will perform well when equities are falling. Prominent examples would be US Treasuries or gold. Both are usually considered “safe haven” assets – assets you want to own when you’re not so concerned about the return on your money but rather the return of your money. We consider these diversifying assets rather than true hedging strategies because there is no guarantee they will perform as we wish.

Cost of holding the strategy

This is always the trade-off – unfortunately there is rarely a free lunch in finance. Every downside protection strategy will come with an associated cost, either an explicit cost or alternatively an opportunity cost. Unfortunately, the more certain the strategy’s payout or benefit in a crisis, the higher the cost usually is.

For example, simply holding fewer equities will generally lead to underperformance in benign, positive market conditions. This can lead to weaker long-term returns – after all, equities have historically had many more positive than negative years.

Conversely holding equity “put” options or insurance carries the explicit cost of the premium paid, which also acts as a drag on returns. This has the relative benefit of being a known and contained cost - but it’s still a drag nonetheless.

Considering diversifying assets, the risk is that they might not perform as expected. For example, US Treasuries sold off in April when equities were also down, which was unexpected. On the other hand, gold performed well, increasing in value as investors sought safety during uncertain times.

Managing the strategy

A final point to consider is how much attention you need to pay to the strategy or whether it’s more “set and forget”. For example, some risk mitigation strategies perform really well when markets fall but are likely to quickly give back those gains when markets recover or even as soon as they stop falling. In these cases, we must be ready to take profits in a timely manner.

Looking ahead, we've noticed that all US assets (stocks, bonds, and the US dollar) were weak – this didn’t help in April. Traditional safe havens like gold and Swiss francs are starting to lose some of their recent gains, potentially creating good entry points soon. Within equities the VIX volatility index has retraced all its gains from early April and equity index option protection strategies are back to normal levels, suggesting now is a good time to reconsider them. We continue to remain vigilant as we look to manage the portfolios’ returns in all types of market environment.

Portfolio manager blog - this week written by

Ian Jensen-Humphreys

Portfolio Manager

Ian is a portfolio manager of the Quilter Investors Cirilium and Creation Portfolios. Ian joined Quilter Investors in March 2020 from Seven Investment Management (7IM), where he was deputy chief investment officer. Ian also spent 15 years at Goldman Sachs in risk management and portfolio hedging strategies.

Ian is a CFA charterholder and has a degree in Physics from the University of Oxford.

Last week's portfolio manager blog

Earnings wrap: What it means for market volatility and company insights

Market volatility in April focused heavily on macroeconomic factors, particularly the impact of President Trump’s tariffs on various countries and consumers. As we concluded the latest round of earnings from US-listed companies, we took the opportunity to assess what these companies are saying both about their delivered earnings and their expectations for the future.

Read the previous blog