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!

Food for Thought!

I'm sure you will have noticed food prices increasing significantly over recent years. Food inflation, particularly in emerging market countries where food is a huge component of spending, can become a real problem. Recently it's been caused by extreme weather conditions leading to poor harvests; with supply falling and demand growing (think population growth), underlying soft commodities have risen. Climate change seems to becoming increasingly apparent in the world and so shocks to harvests of various soft commodities are likely to continue to materialise.

Although higher prices can hurt our wallets, there are ways as investors we can benefit from this. There are many ETFs that invest in the underlying soft commodities and should rise as soft commodity prices rises. There are also agricultural equities/funds that investors can buy. Higher soft commodity prices incentivise farmers to maximise their production in order to maximise profits. This leads to increased spend on high quality machinery, fertilisers and seeds and so companies involved in these should hopefully see increased revenues/profits. Even supermarkets can benefit as they have the ability to pass on cost increases to consumers and maintain/grow margins.

Even without climate change there are trends occurring which should support the 'agricultural' sector. Land is a finite source, and population continue to grow, so it will be necessary to increase yields in order to feed demand. This will mean investment in farm related equipment increases. Shifting dietary habits, particularly as the east adopts a more protein based diet also creates opportunities.

Baring, First State and Eclectica all offer 'agriculture' funds to which try to exploit some of the themes mentioned above.

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!

The UK Economy, an Uphill Struggle

The UK has suffered its fair share of problems since the credit crisis.  In 2010, the Conservative Party was elected as they vowed to sort out the huge financial deficit which built up from years of frivolous spending.  

Huge cuts were promised as people grimaced at the notion of heavy austerity for years to come.  However, after just under three years in power, only 30% of the original cuts have come to fruition.  This has caused deficit levels to miss forecasts weakening the economic growth outlook for the next few years.

Recently, Moody’s, one of the three major rating agencies downgraded the UK from AAA to AA1 and for many this was no surprise.  The UK has one of the highest budget deficits as a percentage of GDP in the whole of the Eurozone.  Furthermore, Public Debt to GDP is at 88.7% and historically this has been below 40% for a AAA rating.  As demographics start to change, the world’s baby boomers weigh on public sector spending.  There may be no way back for many developed nations to the prized AAA rating, only two major countries retain this now; Australia and Canada. 

One way the UK can reduce the piling debt levels is through inflation.  With slow growth forecasted for the coming years it may be the only option.  As the world restructures and deleverages it is important for investors to select the correct asset classes and economies to invest in.  Certainly, the UK Economy is not high on my list, however this does not mean equities listed on the London Stock Exchange are ruled out. 

Of the FTSE100 companies, around 80% of the revenue is obtained from overseas and with some of the largest and most profitable companies listed in the UK, I always maintain exposure to this key market.

A few examples of top UK Equity funds are Liontrust’s Special Situations (for the more aggressive investors) or Royal London’s UK Equity Income which have a great history of selecting  the top UK listed companies.

No more QE....for now

As predicted by 29/39 economists surveyed on Bloomberg the BoE rejected the opportunity to hit the printing press once more. I imagine the debate raged on during the meeting and it was a very close call, and I do believe that over the next few months we will see at least another round of £25bn sanctioned. 

With anaemic growth and the threat of a triple-dip the BoE seems hell bent on trying to stimulate the economy in order to aid growth. There is much debate about QE, in relation to both the intended and unintended threats. It seems to me that there will be no real answers on the merit of QE for many years. My concern over all this printing, on a global scale is inflation. At some point it has to feed through the system, at which time we could experience high levels of inflation. If this inflation hits before we are well on the road to recovery it could be very painful. The typical response to inflation is to raise interest rates, however this is detrimental to growth. Higher rates hurt commercial and residential property markets, which therefore effects banks - and we all know the consequences of this by now! So if the recovery is struggling, governments will not be able to raise rates, which means for a time we will have to live with inflation. 

Inflation hedging can be tricky in portfolios. Index-linked Gilts are very expensive. Real assets such as gold are popular inflation hedges, as is property. A more liquid alternative to property are equities, particularly companies whose revenues are linked to RPI. Utilities and infrastructure stocks revenues are often linked to RPI and so these holdings should provide relatively cheap inflation hedges, and many offer an attractive yield, unlike gold and some prime commercial property. 

It could be a way off yet, but inflation in the long run is something I worry about, more so than deflation, as I often read in the press. It will be one to watch closely, and I fear once we have it, it may be something that takes a while to contain!

Currency and the Impact on your Portfolio

From my experience I have found that many investors (albeit retail) are often unaware of the impact currency movements can have on their portfolio, so I thought I would write a quick post highlighting just this...

When investing in foreign assets, be it debt, equity or commodities, not only are we subject to underlying price movements but also currency movements between our base currency and the foreign assets currency. Lets consider what happens when we buy a US equity fund. We hand over sterling, which is converted into US Dollars and then used to purchase the equities. When we redeem, we sell equities in US Dollars, convert this back into sterling and withdraw our cash. So if the US Dollar strengthens against sterling over the period we 'win' and if it weakens 'we lose'. It's just something one should to be aware of, particularly when many developed nations are actively trying to devalue their currencies.

So you may find the current weakness of Sterling frustrating when travelling abroad, but if like me you are holding foreign equities it can provide a nice kicker to portfolios! Beware, currencies can move quickly in both directions. It is possible to hedge out currency risk by purchasing a hedged share classes when investing in funds, or you could look to add currency trades into portfolios, but these can be costly and difficult to implement. For now let's just enjoy the ride...

Consumer Confidence, a Powerful Economic Driver

Identifying key changes in economic data can provide you with great a insight into successful investment ideas.

A basic strategy which many countries have used to stimulate growth is the multiplier effect.  By increasing the money supply in an economy, it can kick start growth . For example, if a Government decided to build a motorway; the effects of this extra money supply is felt through each economic participant.  Builders, Engineer and Contractors are required for the construction and therefore receive more work.  The increased earnings are then spent on food, clothes, entertainment, etc generating profits for more businesses.  This cycle continues on, as the additional money is felt throughout the economy.

Confidence can have the same effect.  As people become more optimistic about their situation, pressures to save are reduced and spending generally increases.

One of the most effective drivers of confidence are increasing house prices.  Receiving the news property values have risen provides the feeling of increased wealth, although in many cases this is not realisable immediately.

Japan and Abenomics

Since the introduction of the new Prime Minister Shinzo Abe, the Japanese equity markets have reacted strongly to his dovish views and determination to move the economy out of over a decade of inflation.

Since commencing ¥13.7tn of Quantitative Easing (QE), the Yen has depreciated significantly falling approximately 14% against the USD.  Japan is a large exporter and this currency depreciation has increased confidence that profits from companies such as Toyota and Sony will react strongly. 

Although initial actions have been positive, a lot must be done to solve the countries underlying debt problems and ageing population dependencies.  With Debt to GDP of over 220% (compared to Greece at 170%), aggressive monetary policy is needed to kick start the economy.   

Have Gold Equities lost their shine?

Historically gold equities have exhibited strong positive correlation with the gold price. However over the past few years a disconnect has become apparent, with many gold equities falling off a cliff.

Now to try and understand whether this gap will converge or continue to diverge we need to try and work out what has driven the gold price and what has issues have faced the gold miners.


Physical gold has always been seen as a safe haven asset and investors have moved to it in times of economic and political uncertainty. As a 'real' asset it is also seen as a store of value and an inflation hedge. Since the credit crunch we have witnessed extreme economic and political pressures and uncertainty, coupled with tremendous quantitative easing; almost the 'perfect storm' for gold, and as such the price rose dramatically from 2009-2011. 

The Great Rotation and the Hunt for Yield

This is something you may have been hearing more and more, as concerns with the historically low bond yields spread.

Over the past few years especially you would have been well placed to hold bonds, Gilts especially would have returned you a healthy 25% since 2010.  Since the credit crisis in 2008, bonds have been steadily rising as investors sought safe haven returns.  The significant up lift in prices be it Government Bonds, High Yield or Investment Grade debt has caused the income you receive drop drastically.  On a 10 year Gilt today, you would only receive an annual income of 1.89%!

The hunt for yield is on, with cash producing next to nothing and bonds going that way, where can you turn for income?

Two major yielding asset classes remaining are property and equities.  The lower risk alternative, property has been having a varied time depending on your geographical location.