During 2014 all of our portfolios lagged the market. Most of them by a significant margin. You’d think this would concern me, but it doesn’t. The purpose of a hedge is to position a portfolio for more than one outcome when market conditions are uncertain.This means a hedged portfolio will not track the market…by design. This is the reason that most people can’t hedge. They want to participate in every uptick in the market.

The hedging strategies here at Downside Hedge are designed to track the market over very long time frames. They do so by avoiding losses during severe downturns at the expense of lagging during market rallies. The performance charts below provide some good examples.

Our Volatility Hedge performed the best this year. It was up up 6.5%. It is our most aggressive portfolio because it only uses our Market Risk Indicator as a signal. It is 100% long when risk is low and 50% long and 50% hedged using a volatility product such as the iPath® S&P 500 Dynamic VIX ETN (XVZ) when our risk indicator is signalling. It had one signal that whip sawed this year which was the cause of its under performance.

During 2014 both of the Long / Cash portfolios were flat. During much of last year the market internals that we track had unhealthy readings. This caused us to have a hedge on for much of the year. It was a year with weakening market internals but no substantial declines. This was much like 2012. The portfolio has performed better during years where at least a small correction has occurred. 2010 and 2012 are examples. One interesting thing on this chart is that both of the times that the S&P 500 Index (SPX  – black line) got ahead of the Core long / cash portfolio (light green line) have marked long term peaks. We’re getting close to that now. The dark green line is a long / cash portfolio that also recognizes our market risk indicator to go 100% to cash.

Coming in last place is our Long / Short portfolio. It was down -8.6%. It suffered a year similar to 2012 where underlying internals placed a significant drag on the long stocks in the portfolio. This portfolio uses high beta stocks as the longs expecting the higher volatility to be captured over time by purchasing high volatility stocks at low prices after moderate market declines. As a result, it suffers when the market is thinning or reducing risk, but has no corrections. That is what happened in 2014. The long stocks didn’t keep up with SPX after the decline at the first of the year. Then they had even worse performance coming out of the October lows. During both of these periods the hedge (short SPX) added an additional drag on the poor performance of the longs.

Overall it was a fairly poor year to be hedged, but as I stated above, it doesn’t matter because we’re more interested in avoiding losses and beating the market over very long time periods.