Event risk and downside capture: Navigating the uncertain months ahead
Q4 2024 is ‘event risk season’ for allocators and arguably it’s a significant one. Following the recent Trump versus Harris TV debate and as we near the singularity that is the U.S. Presidential Election, what variables should allocators be mindful of?
Political Trading
November’s victor is still unknown, but for whoever wins, and if history is any guide,?Presidential-Partisan Cycles and the Cross-Section of Stock Returns?might still inform future market performance going into 2025.
For those interested in over the counter (OTC) markets, there may be some informative clues versus standard electoral poll numbers. Still, in thin, off-exchange markets, Acadian rightly notes in?Presidential Prediction Markets (Acadian)?that future forecasting can only work if, “aggregate beliefs” are accurate.
Much to the chagrin of some of the voting public, members of Congress may end up trading the election outcome and its resultant sector effects.?Unusual Whales Congress Trading Report?illustrates U.S. politicians’ trading skill, where their performance in 2023, “blew the market out of the water”.
Whether U.S. politicians should trade on a personal account (PA) is an ethical debate for another day. Nevertheless, the University of Florida’s?Negative Trading in Congress (University of Florida)?report did find that state representative’s shorting practices were, “not only common, but also associated with positive abnormal financial returns”.
Downside Portfolio Risk
With 50 days to go, investment committees will undoubtedly be preparing to manage potential downside portfolio risk.?Aurum’s Event Hedge Fund Primer (Aurum)?is a must-read, specifically in relation to opportunistic hedge funds. These funds don’t come without risk, of course, so allocators will need to be aware that, “Sharpe ratios for these funds can vary significantly”.
If one is looking for a halfway house to manage upside or downside risk, especially for buy and hold or trend following strategies, look no further than Semivolatility-Managed Portfolios by academics Daniel Batista and Marcelo Fernandes.
Managing FX risk ahead of November will be particularly important for foreign investors that hold USD assets. If looking for a solid read to stay ahead,?U.S. Election Guide for the FX Market (ING)?is recommended.
With you for insights and intelligence—whatever happens
In the lead up to Brexit and Trump’s election in 2016, event risk was much discussed in the media. Those events came and went, and equities eventually progressed higher. This time it could of course be different, so whether we witness a?Black Swan?or?Black Hole Sun, we shall make sure you’re kept up to date.