Guerite’s Index Options structure allows Guerite to adjust the market risk profile of the equity portfolio, based upon the risk signal of the Guerite Indicator.  During high-risk periods, market risk is reduced or eliminated, while market risk may be unadjusted, or even compounded, when appropriate, during normal risk periods.

Market Risk

Stock investing has two components of risk:  market risk and company-specific risk.

Relative return (long-only, buy and hold-only) investors seek to reduce or eliminate company-specific risk through broad diversification while accepting market risk across stock market cycles.  Relative return investors focus on the long-term positive returns of the market with little regard for the market’s wide swings back and forth between overvaluation and under valuation.

The Guerite Strategy's absolute return philosophy differs from relative return strategies by seeking to reduce or eliminate market risk when economic and market conditions indicate that investors are unlikely to be compensated for taking such risks.  Likewise, during normal-risk periods, the Guerite Strategy may expose the underlying equity portfolio to unadjusted or compounded market risk.

The Guerite Strategy accepts a limited degree of company-specific risk by identifying a diversified mix of mispriced, value-oriented securities and holding them until the securities reach fair value, or higher.  These securities may be individual stocks, ETF's, mutual funds or a combination of these, depending on prevailing market conditions.  Guerite seeks to avoid concentrated positions in specific stocks and/or specific industries.

Absolute Returns

As an absolute return investor, Guerite’s goal is to earn a positive return each year, regardless of market conditions.  Guerite adjusts its exposure to market risk based on signals from the Guerite Indicator. The Guerite Strategy is unadjusted, or even leveraged, market risk, when appropriate, during normal-risk periods.  However, during high-risk periods, Guerite protects capital by removing part or all market risk from the underlying equity portfolio.  Guerite executes its positive absolute return strategy by (i)using the guerite Indicator to identify both high-risk and normal-risk market conditions and (ii)using Index Options to adjust the portfolio's risk profile by hedging market risk during high-risk periods and accepting or even leveraging market risk during normal-risk periods.

In contrast, relative return (buy and hold) investors are unable to vary or transfer market risk from a stock portfolio.  Since their ability to defend against market risk during market weakness is limited, relative return investors measure their returns relative to market indices.  While relative returns are an interesting academic measurement tool, investors actually experience absolute gains (or losses) – making absolute returns the more relevant measurement tool.

Hedging Market Risk

The Guerite Index Options structure consists of buying and selling selected put and call options.  In an attempt to replicate market risk as closely as possible, Guerite selects Index Options that are based on major market indices (such as the S&P 100, S&P 500 and Russell 2000) that reflect, as closely as possible, the capitalization structure of the underlying equity portfolio, while keeping in mind the liquidity of the various index options. 

During periods of very high-risk conditions, Guerite will fully hedge its equity portfolio against market risk.  A fully hedged position has the effect of creating a cash-like position (earning roughly the three month Treasury rate) without the need to liquidate the portfolio.  To the extent that the underlying equity portfolio outperforms (or underperforms) the indices being hedged, Guerite’s investment performance will outperform (or underperform) the equivalent cash investment by the same amount.  For partially hedged positions, Guerite applies the Index Options structure to a percentage of its portfolio.  Guerite modulates its exposure to market risk based on both the Guerite Indicator signals and other economic and market indicators not contained in the Indicator.

 Leveraging Market Risk

During periods of normal-risk conditions, Guerite may leverage, or compound, it equity portfolio exposure to market risk.  A leveraged position has the effect of compounding portfolio movements relative to the market index.  To the extent that the market index being tracked rises (or declines) the Guerite portfolio will increase (or decrease) a proportionate amount, depending on the degree of leverage applied by the Index Options.

The maximum leverage that may be applied to the Guerite equity portfolio is 100% of the value of the equity portfolio at the time of the investment.  This maximum leverage ratio would have the effect of doubling index movements (both increasing and decreasing).

Tax Efficient

A fully hedged position is a tax-efficient method to create a protective synthetic cash-like (hedged) position.  Historically, creating a cash position required liquidating a stock position - causing capital gains taxes.  The Index Options Strategy, in most cases, does not cause a constructive sale, thus avoiding a taxable event.  Additionally, hedges can be increased or decreased as conditions change, again, without affecting the underlying stock position. While hedging does not create capital gains taxes associated with liquidation, there are tax consequences as Index Options are sold or expire.  Guerite Advisors encourages you to speak to your tax advisor, or a Guerite representative, about these tax issues.

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