Abstract

Market returns in the past twenty-two and a half years have been truly extraordinary, over 10% above inflation per year for two and a quarter decades. After these wonderful gains, it is natural to ask what we can do to protect this newfound wealth.

A seemingly natural candidate is plain vanilla portfolio insurance, but there are substantial reasons to question the value of this approach, reasons that we explore below. In thinking about any protective strategy or, more broadly, any investment strategy whatsoever, it is useful to ask the questions:

1. What eventualities do we want to avoid? What risks matter?

2. For whatever strategies are considered, what are the “disaster scenarios” that the client or the board might find unacceptable?

3. What impact does this strategy have on our effective asset allocation?

4. Subject to avoiding unacceptable risks and minimizing exposure to “disaster scenarios,” what are our best strategies for improving returns?

What follows is an array of reflections on ways to protect institutional portfolios against adversity and an exploration of the pros and cons of the various alternatives.