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Managed Risk Domestic Equity 2021 Market Outlook

 

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As investors look back at 2020 there is both a sense of relief as well as dread given the depths of fear and the subsequent hope that the year delivered. Authorities’ tremendous support in the form of fiscal as well as monetary actions, joined by the expectations that vaccine deployment would return activity to normal, created a market bust and boom cycle investors have rarely experienced.  As we look at 2021 there remain concerns around whether realized economic behavior will in fact match the expectations.  The great amount of stimulus required to stabilize the capital markets and prevent catastrophic cyclical depression may have other deleterious unintended consequences. Certainly, unemployment data may remain higher than in the pre-COVID-19 era. Personal services, restaurants, and travel sectors may take longer to recover than currently forecast. This may be due to secular changes accelerated by the COVID-19 related fear or may simply be a greater sensitivity to virus and germ transmission from mass attendance-oriented events.  As we look at both fundamentals, elevated P/Es and option signals, we believe the trust shown by investors that the authorities will not let the markets go down is bordering on imprudence.

Traditionally, the equity markets have bought the story and sold the news but in the recent run-up after the vaccine announcements in November, a historically strong surge of retail call option buying has simultaneously driven equity performance and volatility. At first blush, one might see this as a positive and stabilizing force, but we are concerned that this move has come at elevated valuations and pricing. As a result, the recent wave of retail may not have the stamina to deal with a market correction that could eradicate the “all or nothing” premium nature of options. Interestingly, while this retail move was occurring, most institutions were implementing hedges, selling upside volatility, to reduce risk in anticipation of the January Georgia run-offs and the possibility that vaccine deployment disappoints. The risk for these professional investors that any profit taking or disappointment impair Q1 2021 or all of 2021 returns seems more important than squeezing every last drop out of the bullish expectations.

We would also remind our investors that a self-sustaining recovery could become its own worst enemy as it would potentially drive growth, steepen yield curves, and put pressure on equity valuations.  For example, a ½% increase in the 10- year bond yield from improved hopes (which would still leave the 10- year yield well below an anticipated 1.8% inflation rate) could lead to an approximately 4.5% loss on that position (an estimate based on a 9-year duration times .5%). Historically, as rates rise, equities (in particular, growth style) have not responded well. A yield curve steepening could raise tapering concerns despite the FED’s intentions to keep rates lower for longer and thereby heighten equity volatility. While it is difficult to estimate what the level of equity stress to tapering discussions would be, it is clear that the expected impact on portfolios would not benefit traditional equity – fixed income diversification. We think investors should take this risk seriously.

While short term volatility has receded since the election and vaccine announcements, the 2021 futures curve continues to show concern as the February to August 2021 levels remain above 26. That level would imply a 17.5% probability of a greater than 21% market loss, certainly not part of any strategists’ base case forecast. Whether this is due to the risks that a more progressive administration could increase taxes and regulations or whether it is a pragmatic response to the high levels of recent performance (expecting mean reversion), we would note that reducing risk to those factors while prices are high seems eminently sensible. This is the crux of what our fund does by systematically managing our equity exposure and over-defending levels of loss that normally shake investor confidence. With volatility still at meaningfully elevated levels, we can defray our put spread costs and maintain our protective stance that reduces our correlation to the S&P in market declines.  Given the low levels of realized volatility across several stocks, sectors, and asset classes, we believe the biggest risk investors face is the potential that a risk off event dramatically increase risk across a portfolio in an equity decline. In that event, the James Alpha Managed Risk Domestic Equity Fund (JDIEX) could be of significant value as an offset or diversifier to overall correlation risk in portfolios. Certainly, 2021 may look to have more certainty within its investment scenarios but political, geopolitical, and vaccine related uncertainties remain. With so many investors crowded into many of the same risk-on trades, we think the systematic and meaningful diversification the fund offers should be a core exposure for investors looking to optimize performance.

 

ABOUT EAB INVESTMENT GROUP, LLC

EAB Investment Group, LLC specializes in risk mitigation strategies and works with hedge funds, family offices, high-net-worth individuals, investment companies, and other advisors. EAB Investment Group uses equity and index option strategies based on a proprietary process with the goal to reduce portfolio risk and increase the probability of success. A deep understanding of options pricing enables EAB Investment Group to manage carry and attempt to mitigate costs over time, and potentially optimize monetization.

As of 12/31/2020 3-Month 1-Year 3-Year 5-Year Since Inception 8/3/2015
JDIEX 2.31% 7.32% 6.89% 5.93% 5.12%
S&P 500 12.15% 18.40% 14.18% 15.21% 13.55%

 

Source: Morningstar Direct. Total return for all periods less than one year is an aggregate number (not annualized and is based on the change in net asset value plus the reinvestment of all income dividends and capital gains distributions. The investment return and principal value of an investment will fluctuate, so that shares when redeemed may be worth more or less than their original cost. Investors cannot invest directly into an index. The Fund’s management has contractually waived a portion of its management fees until December 31, 2021 for I, A, and C Shares. The performance shown reflects the waivers without which the performance would have been lower. Total annual operating expenses before the expense reduction/reimbursement are 1.91% for I Shares, 2.16% for A Shares, and 2.90% for C Shares; total annual operating expenses after the expense reduction/reimbursement are 1.90% for I Shares, 2.10% for A Shares, and 2.90% for C Shares1. 5.75% is the maximum sales charge on purchases of A shares. For performance information current to the most recent month-end, please call 888.814.8180.

 

RISKS AND DISCLOSURES

The portfolio will borrow money for investment purposes. Leveraging investments, by purchasing securities with borrowed money, is a speculative technique that increases investment risk while increasing investment opportunity. Derivatives may be volatile, and some derivatives have the potential for loss that is greater than the Portfolio’s initial investment. If the Portfolio sells a put option, there is risk that the Portfolio may be required to buy the underlying investment at a disadvantageous price. If the Portfolio purchases a put option or call option, there is risk that the price of the underlying investment will move in a direction that causes the option to expire worthless. The Portfolio’s ability to achieve its investment objective may be affected by the risk’s attendant to any investment in equity securities.

Shares of ETFs have many of the same risks as direct investments in common stocks or bonds. In addition, their market value is expected to rise and fall as the value of the underlying index or bonds rise and fall. It is possible that the hedging strategy could result in losses and/or expenses that are greater than if the Portfolio did not include the hedging strategy. The use of leverage by the Fund or an Underlying Fund, such as borrowing money to purchase securities or the use of derivatives, will indirectly cause the Fund to incur additional expenses and magnify the Fund’s gains or losses. Because a large percentage of the Portfolio’s assets may be invested in a limited number of issuers, a change in the value of one or a few issuers’ securities will affect the value of the Portfolio more than would occur in a diversified fund.

1The Fund’s investment adviser has contractually agreed to reduce and/or absorb expenses until at least December 31, 2021 for I, A, and C Shares, to ensure that net annual operating expenses of the fund will not exceed 1.79% for I Shares, 1.99% for A Shares, and 3.00% for C Shares, subject to possible recoupment from the Fund in future years.

Past performance is not a guarantee or a reliable indicator of future results. Investors cannot directly invest in an index and unmanaged index returns do not reflect any fees, expenses, or sales charges. As with any investment, there are risks. There is no assurance that the portfolio will achieve its investment objective. Mutual funds involve risk, including possible loss of principal. Certain members of James Alpha Advisors, LLC are also registered representatives of FDX Capital, LLC, member FINRA/SIPC. Saratoga Capital Management, LLC, FDX Capital, LLC and EAB Investment Group, LLC are not affiliated with Northern Lights Distributors. The Saratoga Advantage Trust’s Funds are distributed by Northern Lights Distributors, LLC, member FINRA/SIPC. 11/11 © Saratoga Capital Management, LLC; All Rights Reserved.

Investors should carefully consider the investment objectives, risks, charges, and expenses of the Fund. This and other information is contained in the Fund’s prospectus, which can be obtained by calling 888.814.8180 and should be read carefully before investing. Additional Fund literature may be obtained by visiting www.JamesAlphaAdvisors.com.

THE OPINIONS STATED HEREIN ARE THAT OF THE AUTHOR AND ARE NOT REPRESENTATIVE OF THE COMPANY. NOTHING WRITTEN IN THIS COMMENTARY OR WHITE PAPER SHOULD BE CONSTRUED AS FACT, PREDICTION OF FUTURE PERFORMANCE OR RESULTS, OR A SOLICITATION TO INVEST IN ANY SECURITY.

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