Portfolio Hedging - not for the Faint Hearted

When it comes to investing you generally take a long position(betting prices will rise).  But what happens if the markets crash, how can you protect your portfolio from heavy losses?
One of the most common ways, without selling your holdings is apply a hedged position.  A hedge is where you make an investment to reduce the adverse effects of a negative price movement. 

A great example would be during the credit crisis. If you had a heavy exposure to banking stocks you would have been hurt badly.  However, hedging that position by going short the overall index they resided in, or that direct position would have covered the losses.Hedging is not for the faint hearted and passive investors.  You will need to actively follow your position and implement strategic timing for the fullest effect.

There are many different methods of hedging a position.  A majority use derivatives to execute, however they can be accessed by retail investors though the use of exchange traded funds (ETF).  By taking a short position(betting that security will decrease) you can fully hedge your long position or partially hedge it if you wish to reduce the volatility. 

I mention reducing the volatility; by implementing a short position it will reduce the movement your portfolio makes either up or down.  During times of uncertainty, people use hedging to reduce the downside risk, investing long term after all is down to protecting your losses and maximizing your gains.

You can purchase a volatility index, most notably is the VIX index, this will provide protection in market crashes and if any geopolitical event occurs.  The VIX is currently very cheap as people have come to terms with Eurozone risks and changing monetary policy.

Another merit of using a hedge over selling the position, is due to the nature of derivatives, you can leverage that position allowing you to protect a larger proportion of your portfolio with one holding.  An easily accessible leveraged trade is Soc Gen 5 x leveraged short ETF. 

So next time you go to sell all your shares when you think the market may correct slightly, think again, hedging is always a possibility!

Contrarian Investing - Buying on the Dips

One of the hardest things to try and achieve in investing is market timing; I know it is something I have never managed to perfect, and many other more talented investors have also admitted defeat! 

However, what I do find interesting is how people approach investing. If a stock falls 10% then there is an argument that that stock is less risky than one that has risen 10% as the likelihood is the bad news has already been priced in to some degree and you are investing at a lower base.  However, time and time again people buy in on the "way up" and sell on the "way down".

I thought this article would be poignant today given Standard Chartered's announcements of a 10th consecutive year of income and profit growth as well as an increase in full year dividend of 10.5%. Over the summer Standard Chartered were hit by the Iran money laundering scandal which saw around 19% shed from their share price in 24 hours. Many investors I am sure panicked fearing almighty fines on the bank and sold their positions. If as an investor however, you had bought into the stock immediately following this scandal you would be sitting on a profit of around 46% (not factoring in any dividends!). Standard Chartered were fined around $700m for the scandal, but that has failed to dent profits significantly and the Emerging Market focused bank continues to perform strongly. 

Source: Google Finance

Of course there are examples where a stock has fallen sharply on the back of bad news and continued to fall, so investors need to keep an eye out for this. I think the key is to ask yourself, what has caused the stock to fall, what is the consensus view and have the fundamentals changed. If you believe the market has overpriced the bad news, and that in fact the company can recover then it could be a good buying opportunity. 

For investors who don't have the time or expertise for such type of investing there are contrarian funds available. Probably the most famous is M&G Recovery which has a brilliant track record, and a particular favourite of mine is Investec UK Special Situations.

Contrarian investing often means going against consensus and is a bold move, but if it is good enough for Warren Buffett then it is good enough for me!