WINNING BY NOT LOSING: How Much You Make Depends Significantly on How Much You Don’t Lose

Uncertainty in investing and the markets remains at the forefront for investors. The COVID-19 pandemic has seen market volatility spike to levels that rival history’s most extreme conditions. The descent from a record high in February to bear market territory in March was extraordinarily swift and acutely brutal.

But crises are a fact of life in the financial markets, even across the relatively short term. In just the last decade, we’ve endured the 2008–2009 Financial Crisis, the 2010 Greek government-debt crisis, and the 2011–2012 European debt crisis. Each of these disruptions were different, but there were also common threads running through them. We’ll suggest there was much to be learned — enough in fact to help navigate the coronavirus pandemic and the next crisis to come.

Volatility Matters

Markets, of course, are always going up and down to some degree. It’s what we call volatility. Enter the CBOE Volatility Index.

Vix Index of Implied Volatilities (% per annum)

Known most commonly by its ticker symbol VIX, the index represents a real-time estimate of future volatility, both to the upside and the downside. The VIX is often referred to as the “fear gauge” because it tends to rise when stocks go down.

In practice, the various needs of volatility-sensitive investors, which include certain mutual-fund managers among others, tend to produce a degree of equilibrium in low–to-medium volatility periods. But when a volatility shock arrives, such as a pandemic, the professionals start to sell. And the higher their positioning, the faster they unload.

The result?  Seemingly random selling, disappearing liquidity, and the convulsions that just rocked the stock market. In the recent selloff, from peak to valley — and in stunningly short order — the S&P 500 fell nearly 35% as pandemic fears spread.

And So Does Downside Protection

For investors with retirement savings or other funds invested in the stock market, the COVID crash surely lowered the value of their holdings. That’s bad. But here’s what’s worse: An investor who was unfortunate enough to suffer the full 35% drop will need his or her portfolio to gain more than 50% just to get back to even.

The message in this arithmetic is that mitigating downside, or preserving capital, is more important than capturing upside, growing capital, to the same magnitude. It’s the frightening mathematics of how losses — especially large ones — work.

So, if we know how outsized volatility can impact investment returns, what can we do? We’ll suggest an effective mechanism is more controlled portfolio volatility. Said another way, reducing a portfolio’s volatility reduces its drawdown.

If nothing else, the recent market selloff should remind us of the common threads that ran through previous market crashes, including how quickly and painfully investment losses can mount. Most importantly, it illustrates how avoiding large losses and minimizing volatility is the hallmark of a great portfolio manager.

Enter Shelton’s Core Value Strategy

Selling call options is one approach the Shelton Core Value Fund (EQTIX) utilizes to mitigate risk in the equity markets. Option prices typically move in tandem with volatility and thus premiums received tend to be higher, offsetting some of losses on the way down. Currently, the Fund has a lower standard deviation and higher return than the Large Value category as defined by Morningstar. This means it has a lower amount of risk vs the category while still generating above average returns. Additionally, EQTIX has a downside capture ratio over 30% less than its peers*, meaning the Fund does not participate in as much of the downward trend by a sizable amount.

There are a variety of ways an advisor can seek to limit volatility in their clients’ portfolios and a well-managed option strategy is certainly one of them. Shelton Capital has a robust and knowledgeable options team who manages mutual funds such as EQTIX and separately managed accounts that can be customized to meet a client’s goals.

Important Information 

It is possible to lose money by investing in the Fund. Past performance does not guarantee future results. Fund information is not intended to represent future portfolio composition. Portfolio holdings are subject to change and should not be considered a recommendation to buy individual securities.

Investments in derivatives may be risker than other types of investments. They may be more sensitive to changes in economic or market conditions than other types of investments. Many derivatives create leverage, which could lead to greater volatility and losses that significantly exceed the original investment. Positions in equity options can reduce equity market risk, but can limit the opportunity to profit from an increase in the market value of stocks in exchange for upfront cash as the time of selling the call option. Unusual market conditions or the lack of a ready market for any particular option at a specific time may reduce the effectiveness of option strategies and could result in losses.

Investors should consider a fund’s investment objectives, risks, charges and expenses carefully before investing. The prospectus contains this and other information about a fund. To obtain a prospectus, visit www.sheltoncap.com or call (800) 955-9988. A prospectus should be read carefully before investing.

© 2020 Morningstar, Inc. All rights reserved. The information contained herein: (1) is proprietary to Morningstar and/or its content providers; (2) may not be copied or distributed; and (3) is not warranted to be accurate, complete, or timely. Neither Morningstar nor its content providers are responsible for any damages or losses arising from any use of this information.

*Compared to the Morningstar Large Value Category as of April 30, 2020

Distributed by RFS Partners, a member of FINRA and affiliate of Shelton Capital Management. 2020

INVESTMENTS ARE NOT FDIC INSURED OR BANK GUARANTEED AND MAY LOSE VALUE.