Steven Smith’s Swan Asset Management aims to give investors some peace of mind during uncertain times. Swan is actually an acronym that stands for “Sleep Well At Night,” and through three Covestor models that focus on hedging volatility, this is exactly what Steve Smith’s firm hopes to achieve.
Swan looks at equity investments from a fundamental perspective and tries to buy great companies at great value. While generally following a bottom-up process, top-down considerations also enter into play when selecting stocks. Larger companies are the primary focus, but mid-cap names are occasionally included as well.
The International Hedged Equity model combines stability, income and growth through investments in international stocks. The Hedged Equity model reflecting the stability and income of bonds as well as the growth potential of stocks. The Christian Agape Hedged Equity combines stability, income and growth through investments in companies adhering to Christian moral principles.
At right Steve is pictured at his Cochranville, Pennsylvania ranch with a couple of his horses. We had a chance to ask Steve a few questions about his approach.
Q. How does your hedged portfolio strategy work?
I use inverse ETFs (e.g. ProShares UltraPro Short S&P 500 ETF (NYSE: SPXU)) or volatility ETNs (e.g. iPath S&P 500 VIX Short-Term Futures ETN (NYSE: VXX) or iPath S&P 500 VIX Mid-Term Futures ETN (NYSE: VXZ)) to hedge against market corrections, since options aren’t yet available on the Covestor platform. The approach is designed to deliver relatively steady performance, or a smoother pattern of returns than the S&P 500.
Another objective is to deliver similar – if not better – returns over time, since better returns with less volatility is the definition of a job well done in portfolio management. In shorter periods of time, especially when the Federal Reserve is boosting the market with QE2, that objective of better returns is tough to achieve.
Q. How does a downturn like we’ve seen the past couple months affect your thinking about your other holdings?
The recent sell-off has presented an opportunity for hedged strategies to demonstrate their effectiveness. Swan hedged models on the Covestor platform are being managed with an 80% equity allocation and a 20% cash/hedged allocation. I try to have cash along with some hedged positions in place at all times and increase the hedge up to the full 20% allocation occasionally.
Since I take a more fundamental approach, I don’t have technical signals that I look for. Recently, spreads on investment grade and, even more so, high yield bonds have been widening. At the same time that bond investors were showing concern about the US economy, equity investors seemed complacent. With bond investors getting worried, along with the possibility that the Greek debt crisis may end badly, I recently decided it was appropriate to increase the hedge position to its full allocation. Inverse ETFs, mainly SPXU, are the main tools I use to hedge, since ETNs include the credit risk of the issuer and that’s just another risk I don’t want to worry about.
My stock selection revolves around economic profitability and intrinsic value. Equity holdings tend to be more defensive. On top of that, my bias is toward higher yielding stocks in this market environment. The additional income helps pay for the hedge and contributes to overall return when market appreciation may be harder to come by in this slack economy.
Q. What signal do you use to decide when it’s time to get defensive?
The economy has shown no meaningful response to extraordinary stimulus, both monetary and fiscal. If the Fed ends QE2 without introducing a new form of liquidity injection, the market could continue to its sell-off. Politically, introducing more monetary stimulus could be a problem for the Fed. And with deficit concerns, additional fiscal stimulus is not likely.
My view, at the moment, is that there are considerable downside risks facing the market and limited upside opportunity. Days like today (6/27) make me look wrong, except for the constrained volume in up markets. Even when stocks trade higher, there doesn’t seem to be much conviction. Algorithmic trading and the potential for another flash crash add to the rationale for well-hedged positions.
Thanks so much for the insight to your models, Steve.
My pleasure.
