Strategic Risk Management: Designing Portfolios and Managing Risk

Imagine a strategy that thrives when fear grips the markets, when prices tumble and uncertainty reigns. This is the essence of crisis alpha — the ability to generate returns precisely when most investors suffer losses. One such strategy is time-series momentum, a method that dynamically adjusts positions based on recent price trends across multiple asset classes like equities, bonds, commodities, and currencies. Unlike traditional buy-and-hold approaches, momentum strategies resemble the payoff of a long straddle option, where gains come from significant moves in either direction. This unique feature leads to positively skewed returns, meaning occasional large wins offset many small losses.

Delving into decades of data from 1960 to 2015, we find that momentum strategies consistently perform well, even through turbulent periods marked by severe equity and bond drawdowns. The strategy’s core is to weight recent months’ returns heavily—particularly the past 1 to 4 months—because these recent trends best predict near-future price movements. This insight aligns with the empirical replication of the BTOP50 managed futures index, a well-known benchmark for trend-following funds.

For example, during the 1974 bear market, momentum strategies that focused on recent returns delivered strong positive performance, cushioning portfolios from the broader market’s pain. This protective quality is not confined to equities; bond markets, often overlooked as a source of crisis alpha, also benefit from momentum strategies, especially during periods of rising yields and market stress.

Furthermore, the strategy’s design includes volatility scaling to normalize risk across assets, ensuring that no single market dominates the portfolio’s risk profile. This approach provides stable, risk-adjusted returns over time, creating a resilient shield against market shocks.

In essence, crisis alpha through momentum is about harnessing the market’s natural tendencies—trends that persist beyond initial news reactions, creating opportunities to profit when others falter. It is a dynamic, adaptive approach that rewards patience and discipline, offering investors a beacon of hope in stormy financial seas.

As we transition from understanding crisis alpha’s foundations, we now turn to the question of whether entire portfolios can be designed to withstand crises, blending various defensive strategies to enhance resilience and reduce losses.