Ass-Covering Is So Passé: Cost Of Protection Drops To 6 Year Low

Ass-Covering Is So Passé: Cost Of Protection Drops To 6 Year Low

I would hope that if you frequent these pages you’ve put on your hedges.

Although I suspect that many of you haven’t.

The problem with hedging is that it costs money. When you throw in the lost carry from not being fully invested on the way up, you’ve got the recipe for money manager performance anxiety. And that, in turn, causes people to stay all-in longer than they should. Here’s how Citi put it last month:

If there is such a thing as a ‘Holy Grail’ in the credit market anno 2017 then surely the no-cost decompression trade is it — the trade that performs, if spreads widen, but doesn’t cost a bundle of carry if they don’t. Spreads could evidently still compress further under some (optimistic) scenarios, but most portfolios are long to benchmark already and at current levels the potential downside greatly exceeds the potential upside no matter how you look at it. That leaves a glaring asymmetry. Instead, we’d argue the principal concern people have with decompression trades here is that they tend to be negative carry. In a benign market, it is easy enough to de-risk by shortening maturities, selling higher beta bonds and/or moving to defensive sectors. But as illustrated in our 2017 outlook, when spreads are low, volatility is low and dispersion is low, a few basis points of carry can matter a lot to a fund’s percentile performance against peers. And against the short-term metrics by which performance tends to be measured many will struggle to forego the incremental carry — until a negative trigger becomes immediately obvious.


But on the bright side, popular (and, more importantly, liquid) hedges are especially cheap in the current environment.

So if Trump’s orange face paint and/or the bright yellow glow of the Snapchat IPO has thus far blinded you but you’re now ready to shake of the myopia and protect your downside, consider the following from Goldman.

Via Goldman

The cost of liquid long-dated hedges in equity and credit has collectively reached its lowest level in six years following the decline this week. The last time macro hedge costs were near this level across assets was in July 2015 (see Exhibit 1). While not likely the cause of the pullback in August of 2015 (the mini-flash crash), the lack of hedges in investor portfolios likely exacerbated the sell-off.



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