How to hedge your portfolio

TOO MUCH MARKET RISK?: HEDGING IS INSURANCE, SO YOU MAKE MONEY REGARDLESS

It is a risk-management strategy to limit or offset the probability of loss from fluctuations in prices of commodities, currencies or shares.

With the stock market near historical highs amid continued global and local drama, now could be a good time to rethink your investment strategy.

• Losing money feels twice as awful as making it feels good. Preventing loss is psychologically valuable. • People don’t have infinite time horizons. In or close to retirement? That 10% correction or 20% bear market matters. • Distributing risk and having a solid floor is good practice. It’s like life/medical insurance: you don’t need it until you do. • Hedging may be another diversification method. Like having a bond or gold allocation, having nonequity-correlated or inversely correlated assets can improve returns.

It’s not necessary for an investor to carry a hedge at all points of their investment, but normally a crisis or fall leaves enough telltale signs and scars to warrant thinking about it. Volatility generally increases ahead of a sharp move.

Here are some ideas I’ve used:

Over the last year, cash has been king in contributing to portfolio growth and reducing volatility. Having a solid cash allocation is the simplest approach to hedging your bets and reducing risk shortto medium term. Having too much cash can lower your return if the market heads up. Use a dynamic cash hedge: a strategy that raises your cash allocation and protects returns in falling markets, lowers your cash allocation and puts more to work in rising markets. Look at rebalancing your portfolio quarterly, if needed.

Rotate into defensive sectors or assets, e.g. consumer staples or utilities. This strategy is more a mix between tactical diversification and hedging, rather than a pure hedge.

It’s perhaps the most practical and comfortable option for many, as it maintains exposure to growth assets and nets profits from them, but tactically shifts the portfolio to favour low or negatively correlated assets.

You can profit in both rising and crashing markets. It’s said that there is always a bull market somewhere. An investment professional assessing your portfolio can help guide you to determine where you are and how you want to protect yourself.

Some of the best, most consistent-performing fund managers are private endowment managers, e.g. funds owned by universities or charitable organisations.

Their secret for consistent returns and fewer losses boils down to how they diversify. They use investments insulated from crashing markets. They don’t have full market exposure, and neither should you.

There’s a case for alternative investments, e.g. direct real estate investments (not REIT shares/ funds), absolute return portfolios, private equity, structured notes or holding a gold coin or diamond or two.

These alternative strategies all have their own risks and returns but little or no market risk. Generally, a 10%-15% allocation of your money to such investments is the sweet spot.

Unfortunately, they aren’t easy to procure on your own and are usually quite capital intensive.

Technology and new products have helped close this gap and and more advisers are specialising in these types of investments.

Rosemary Lightbody Association for Savings and Investment SA