Po­si­tion and pro­tect

Finweek English Edition - - INVESTMENT -

One of the ac­cepted givens in the stock mar­ket is that ev­ery so of­ten we will have, at best, a bear mar­ket (de­fined as 20% down from the highs) or at worst a mar­ket crash (loosely de­fined as a sud­den 20% de­cline down in a short time). These def­i­ni­tions are far from ex­act, but ba­si­cally I am talk­ing about when the value of your port­fo­lio de­clines a sig­nif­i­cant amount over a rel­a­tively short or medium-term pe­riod (days to maybe a year or more). The point is that mar­kets never go up for­ever; there will al­ways be pe­ri­ods when the trend is down.

Many of us spend a large part of our time wor­ry­ing about when this down­trend will oc­cur and plan on sell­ing be­fore such an event takes place in or­der to get back in at the bot­tom. In a per­fect world that would be ideal: sell­ing at the top and buy­ing at the bot­tom would markedly im­prove our wealth. But as I have writ­ten be­fore in this col­umn, that is a to­tal pipe dream, we’ll never exit at the top and we will just as cer­tainly miss the bot­tom, leav­ing us ac­tu­ally poorer for the at­tempt.

So how do we po­si­tion our port­fo­lio for the in­evitable mar­ket de­cline? As we have writ­ten be­fore, the best way to sur­vive a mar­ket de­cline is to own se­ri­ously top-qual­ity shares – the best stocks in the best sec­tors. Sure, these stocks will also see their share prices fall­ing with the over­all mar­ket and there is no cer­tainty that the stocks will fall less. In fact, if they are real qual­ity they may have run up fur­ther than the aver­age and hence could well fall by a larger per­cent­age on the way down. But the big­ger pic­ture is that if you own the best, these stocks will sur­vive and re­cover quickly and make new highs long be­fore the sec­ond rank- ers have re­couped their losses.

I al­ways harp on about this, but the best stocks in the best sec­tors con­tinue to dom­i­nate and there­fore give the best re­turn but also re­cover quicker. Far too of­ten we buy stocks in the hope that these will rocket higher and make us wealthy in a hurry – but that sel­dom, if ever, works. Pick the best sec­tor and then find the win­ner in that par­tic­u­lar sec­tor.

Aside from buy­ing the win­ners, how do we pro­tect a port­fo­lio? In truth, that is all I do: I have a small list of qual­ity stocks and I hold them for­ever, with one ex­cep­tion. If they lose their way and no longer dom­i­nate their sec­tor I will exit them and pur­chase the new win­ner in that sec­tor.

There are how­ever other op­tions to pro­tect you in a mar­ket down­turn, such as hedg­ing. The idea be­hind hedg­ing is to buy de­riv­a­tives that will in­crease in value as the mar­ket de­clines. These could be op­tions/ war­rants or short po­si­tions in con­tract for dif­fer­ences (CFDs), sin­gle­stock fu­tures (SSFs) or even a short po­si­tion in the Alsi fu­tures.

All of these hedg­ing al­ter­na­tives carry costs, not only trans­ac­tion and fund­ing costs but also the cost of them fall­ing in value, as the mar­ket is mov­ing higher. So while your over­all port­fo­lio is ris­ing, this hedge is tak­ing some of the shine off your over­all prof­its. The other prob­lem is that a per­fect hedge is al­most im­pos­si­ble.

So, the bot­tom line is that I do not hedge against a mar­ket down­turn even though I know for cer­tain one is com­ing (but I never know when it is com­ing). Rather, I man­age the risk by buy­ing qual­ity that en­ables me to sleep at night dur­ing the good and bad times.

Newspapers in English

Newspapers from South Africa

© PressReader. All rights reserved.