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Global Quantitative & Derivatives Strategy 11
March
2020
Defensive
Risk
Premia
Systematic
Strategies
for
the
Risk-Off
Times
In
the
current
paper,
we
focus
on
risk-premia
strategies
that
are
expected
to deliver
performance
when
major
asset
classes
and
in
particular
equities
incur sell-offs. Our proposition relies on diversification among timeframes, profit drivers, asset classes and P&L profiles. We put forward three groups of defensive risk premia strategies ‒ core, tactical hedging, and satellite. The core defensive strategies typically have low capacity constraints and longer track
records.
We
discuss
the
profit
drivers
and
empirical
performance
of asymmetric
trend-following,
synthetic
defensive
baskets,
mean-reversion, quality and low volatility equity factors. A
comprehensive
flow-based
sentiment
indicator
and
a
cross-asset
volatility- based sentiment indicator are used to determine the right time to place hedges. Satellite
strategies
as
intraday
momentum
and
correlation
breakout
capture bring additional diversification in risk-off times. An
optimization
process
that
takes
into
account
the higher
portfolio
moments and
the
time-series
of
the
hedged
asset
is
implemented
to
construct
a
robust portfolio of defensive risk premia strategies. Global
Quantitative
and Derivatives
Strategy
Dobromir
Tzotchev,
PhD
AC
(44-20)
7134-5331
dobromir.tzotchev@jpmorgan.com
J.P.
Morgan
Securities
plc
Rahul
Dalmia
(44
20)
7134-5883
rahul.dalmia@jpmorgan.com
J.P.
Morgan
Securities
plc
Ada
Lau
(852)
2800-7618
ada.lau@jpmorgan.com
J.P.
Morgan
Securities
(Asia
Pacific)
Limited/
J.P.
Morgan
Broking
(Hong
Kong)
Limited
Twinkle
Mehta
(91-22)
6157
3324
twinkle.mehta@jpmchase.com
J.P.
Morgan
India
Private
Limited
Marko
Kolanovic,
PhD
(1-212)
622-3677
marko.kolanovic@jpmorgan.com
J.P.
Morgan
Securities
LLC
Figure 1: Diversification benefits of an optimized defensive portfolio Table 1: Performance statistics
Optimized Defensive Portfolio
S&P500
Combination of
Optimized Defensive Portfolio
and S&P500
Source:
J.P.
Morgan
Quantitative
and
Derivatives
Strategy
Ann
Return
9.7%
6.20%
15.9%
Ann
Volatility
14.5%
18.60%
15.7%
Sharpe
0.67
0.33
1.01
Max
DD
34.4%
61.40%
24.6%
Skewness
1.03
0.16
0.26
Kurtosis
30.23
12
4.71
Source:
J.P.
Morgan
Quantitative
and
Derivatives
Strategy
See page 63 for analyst certification and important disclosures, including non-US analyst disclosures. J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. www.jpmorganmarkets.com
Table of Contents Defensive Risk Premia Portfolios
............................................... 3 The Case for Defensive Risk Premia Strategies
......................................................... 3 Defensive Risk Premia Strategies Selection
............................................................... 3 The Benefits of a Diversified Portfolio of Defensive Risk Premia Strategies
............. 5 Portfolio Construction for Risk-Off Times
................................................................. 7 Core Defensive Risk Premia Strategies
.................................... 7 Asymmetric Trend-Following
.................................................................................... 7 Synthetic Defensive Baskets
..................................................................................... 17 Single Asset Mean-Reversion
.................................................................................. 29 Defensive Long/Short Equity Factors
...................................................................... 38 Tactical hedging
............................................................................ 42 Comprehensive Flow-based Sentiment Indicator
..................................................... 42 Cross-asset Volatility-based Sentiment Indicator
..................................................... 44 Satellite Strategies
........................................................................ 46 Intraday Momentum
................................................................................................. 46 Correlation Breakout Capture
................................................................................... 49 Portfolio Construction for Risk-off Times
............................... 51 Performance of the Optimized Defensive Portfolios
................................................ 52 Optimized Portfolios of Safe-Haven Assets
............................................................. 54 Appendix
.......................................................................................... 57 P&L Profile Asymmetric Trend-Following System
................................................. 57 P&L Profile Two-Sided Mean-Reversion
................................................................ 58 P&L Profile Defensive Mean-Reversion
.................................................................. 59 Performance in Various OECD regimes
................................................................... 60 Performance in Various VIX regimes
...................................................................... 61 Performance during the 10 Biggest S&P500 Drawdowns
........................................ 62 Performance during the 10 Biggest Weekly S&P500 Drops
.................................... 62 Performance during the 10 Biggest Daily S&P500 Drops
........................................ 62
Defensive Risk Premia Portfolios The Case for Defensive Risk Premia Strategies Risk premia strategies have been put forward as a diversifying proposition ‒ their returns stream is uncorrelated to that of major asset classes and also the correlation among the component strategies of the risk premia portfolio is low.
While many of the risk premia strategies have remained uncorrelated to each other (see for example our statistical analysis in
Quantitative
Perspectives on Cross-Asset
Risk
Premia
from 17 January 2020), the
correlation of risk
premia to
equity markets and the implicit long equity exposure has been on the rise (please refer to the empirical analysis in „Risk premia sensitivity to rates/equities, implications of JPM 2019 FICC outlooks and our latest timing forecasts‟).
The occurrences of simultaneous sell-offs in both major markets and risk premia strategies have become more frequent and risk premia portfolios have started to exhibit negative skewness (please see our analysis of tail risks in risk premia strategies and portfolios in Quantitative Perspectives on Cross-Asset Risk Premia (from 6 March 2019).
In the current paper, we focus on risk-premia strategies that are expected to deliver performance when major asset classes and in particular equities incur sell-offs. In this respect defensive risk premia portfolios consist of systematic strategies that can diversify and protect both traditional asset classes as well as for mainstream risk premia portfolios.
Defensive Risk Premia Strategies Selection Our proposition for a defensive risk premia portfolio heavily relies on diversification and consists of a combination of core defensive strategies, tactical hedging, and satellite strategies.
Figure 2: Three groups of defensive risk premia strategies
Source:
J.P.
Morgan
Quantitative
and
Derivatives
Strategy
While detailed description of all strategies can be found further in the body of the paper below, we briefly describe the main features of the various groups of strategies and their components.
Core
defensive
strategies have low capacity constraints and longer track records that warrant a more sizable allocation. Typically
core
defensive
strategies
are
strategies
that
are
well-known
to
investors.
Nevertheless,
we
have
made
design modifications to some of them in order to enhance the defensive characteristics and we have also put forward some new proposals. Core Strategies Defensive Risk Premia
Tactical Hedging Satellite Strategies
In
our
case
the
core
defensive
strategies
consist
of
asymmetric
trend-following,
synthetic
defensive
baskets,
single-asset mean-reversion, quality, and low volatility low/short pure equity factors: Asymmetric
trend-following
is
a
modification
of
our
trend-following
strategy
(Designing
Robust
Trend- Following System by Tzotchev et al.) with some enhancements aimed at isolating and improving the performance in risk-off times. In particular only one-sided positions that correspond to a risk-off environment are taken: short positions in equities and commodities (except for gold) and long positions in bonds and USD. Synthetic
defensive
baskets are
a new
proposition
based
on
our
market-neutral
carry
strategy (Market-Neutral Carry Strategies). The strategy relies on opportunistic capture of both carry and momentum income opportunities which facilitate the maintenance of a hedging position in the desired direction. Single-asset
mean-reversion
has
also
been
a
popular
strategy
and
in
our
analysis
we
focus
on
not
only
the empirical but also the theoretical underpinnings of the strategy‟s profit drivers in risk-off times. The defensive characteristics of quality and low volatility low/short equity factors have already been discussed in Equity Risk Premia Strategies primer by Kolanovic (2014). For the current application, we use the pure quality and
low
volatility
factors
described
in
The
Quest
for
Pure
Equity
Factor
Exposure
and
we
add
an
additional defensive tilt to those factors allowing a negative exposure to the market in the optimisation.
The tactical
hedging approach aspires at determining the right time to place hedges and their optimal size. We rely on a systematic signal that should provide us wit...
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