Portfolio Risk Control — VCM’s Technical Overlay
Virtue Capital Management (VCM) offers a technical risk-mitigation strategy to manage risk in a client’s equity portfolios. While there are numerous ways to control portfolio risk, the basic objective is to participate in bull markets while attempting to mitigate the impact of bear markets. Many portfolio management strategies employ the use of options, while other strategies utilize a more technical risk-on/risk-off approach. VCM has chosen a mathematical approach that uses technical indicators to identify periods of risk-on/risk-off. This approach was selected due to its low-cost structure and its ability to be implemented with lower minimum investments. While no strategy works perfectly in every market environment, attempting to minimize the large loss potential of bear markets can dramatically help preserve and increase wealth over time.
VCM’s uses a so-called “technical overlay” to mitigate downside risk. It employs a series of technical indicators that dictate either a risk-on (fully invested in the reference ETF) or risk-off posture (investment in a high-quality no-transaction-fee bond ETF).
Recouping Big Losses Is Tough
The math of percentages shows that as losses get larger, the return necessary to recover to break-even increases at a much faster rate. A loss of 10 percent necessitates an 11 percent gain to recover. Increase that loss to 25 percent and it takes a 33 percent gain to get back to break-even. A 50 percent loss requires a 100 percent gain to recover and an 80 percent loss necessitates 500 percent in gains to get back to where the investment value started. If assets are actually sold during a market downturn, then bouncing back is even harder.
Components of the Strategy
There are two components of the VCM risk-control strategy: the technical overlay and the underlying portfolio. The technical overlay is a combination of mathematics, technical indicators employed, and the data series utilized to execute the strategy. The technical overlay seeks to identify inflection points and thus “triggers” the risk-on/risk-off posture of the portfolio. The underlying portfolio is a low-cost ETF with exposure to a specific asset class or style. When the technical overlay indicates a risk-on posture, the strategy is invested in the underlying ETF. When the technical overlay indicates a risk-off posture, the strategy is invested in the AGG (Barclay Aggregate Bond Index).
The Technical Overlay:
The Mathematics – Exponential Moving Average (EMA). An Exponential Moving Average (EMA) is a type of moving average similar to a simple moving average, except that more weight is given to more recent data. This type of moving average reacts faster to recent price changes than a simple moving average.
The Technical Indicators. The strategy utilizes a series of intermediate exponential moving averages of US equity closing prices to determine inflection points. When these averages cross, risk-on and risk-off points are triggered. Multiple scenarios were tested, and this methodology provided advantageous trigger points that avoid material downside returns while participating in most of the upside. Moving Average Convergence Divergence (MACD) is a trend-following and trend-momentum indicator that measures rates of change between two EMA’s. The MACD measures technical indicators across a different time series to indicate and subsequently validate a buy or sell signal.
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