Investor Portfolio: Hedging Products September 2, 2016

When Billionaire hedge fund manager Seth Klarman was asked about what it takes to be a successful investor, he replied, “The conviction to concentrate your portfolio in your very best ideas, and the common sense to nevertheless diversify your holdings.”

One of the most common mistakes I encounter among investors is: buying too much within the same asset class. Although it may create a wide diversification within a class but it is too narrow as an investment portfolio.

An ideal portfolio could hold:

  • Cash in SGD and USD
  • Hedging products
  • Bonds
  • Inflation-sensitive assets
  • Stocks and exchange trade funds

My hope for retail investors is a resilient approach towards your stocks portfolio. Steward what you own well, as it will help safeguard the things in life that are important to you.

Hedging a position is basically making use of various investment means to reduce the impact of volatile price movements of a stock/sector/country in a portfolio. A few such examples are listed below. However, do note that this is purely educational and I am not in any way suggesting a buy/sell call. Please speak to your trading representative for more information.

 

Gold ETFs

Gold ETFs are widely considered as a protection against a volatile currency or negative stock market shocks. A common trend in the world now is countries devaluing their currencies, which has sometimes produced unexpected results. This in turn would lead to capital inflows into safe haven assets.

Advantages Disadvantages
Hedge against volatile currency or negative stock market shocks Arbitrary Value – Sentiment Driven
Hedge against inflation No generation of intrinsic value
Not so correlated with broader market

The months of Feb to Apr 2016 showed a weakening Dollar as investors lower their expectations of the pace and frequency of rate hikes against a stronger Yen. This in turn led to an increased demand for gold ETF, so you do see some inverse correlation there.

Source: POEMS 2.0

Inverse ETFs

Alternatively, there are inverse Exchange Traded Funds (ETFs) that track the opposite price of our underlying asset classes via short-selling or futures contracts, for example, UCO Bloomberg Ultra Crude Oil (Long – Blue) vs SCO Bloomberg Ultrashort Crude Oil (Short – Yellow). Inverse ETFs are popular in a bear market because of their increase in value and the convenience of buying and trading. SCO has been rising for the past one to two years due to declining oil prices.

Advantages Disadvantages
Market Liquidity Returns vary drastically in the long run
Ease of trade – Useful in the short run Higher expense Ratio
Hedge against down side exposure  
Source: POEMS 2.0

Source: POEMS 2.0

 

Diversification – Various Industries

Perhaps you are hesitant to explore complex derivatives – a loose hedge could be made. Continuing with the topic on oil, assuming you have oil exposed counters and you do not wish to exit the position. You may hedge with companies that generally benefit from a low oil price scenario. An example listed below, airline and transport sectors like SIA (teal) or FedEx (green) are some good examples of such companies which can hedge against Keppel (red) or Sembcorp Ind (blue).

Source: POEMS 2.0

Source: POEMS 2.0

Advantages Disadvantages
Simple – No complex derivatives Not a “perfect” hedge

There are also other trading products which can work as a hedge. Contract for Difference (CFD) is another possible hedging instrument to consider. All strategies mentioned in this article have tradeoffs – whether it is in terms of cost or systematic risk, a successful hedge can never be guaranteed.

In conclusion, whether there is a bull or bear market, there would be opportunities to hedge and to gain. The main question is whether you allow your portfolio to adapt or choose to succumb to market forces and accept the current state of your portfolio. Steward your portfolio with our help today. Talk to a dealer at your nearest Phillip Investor Centre.

All ETFs used in the charts are proxies to a selective sector or industry and purely used for educational purposes.

Disclaimer

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About the author

Sky Kwah Wen Yao
Dealing Manager
Raffles Place Dealing Team

Sky Kwah is part of the POEMS Equity Dealing Team that provides dealing services to over 17,000 trading account customers.

Sky gives talks in tertiary institutions like NYP & SIM and he often conducts seminars on Fundamental Analysis, most recent was at the Investfair 2016. He particularly focuses on value stocks in Singapore and the US with a top-down macro approach. He is frequently interviewed by Media Corp News 938Live radio station as a market commenter and he hopes to help clients become better stewards of wealth and believes in succeeding in what truly matters – the fullness of life.

Sky holds a Bachelor Degree of Commerce with a triple major in Financial Accounting, Investment Finance, and Corporate Finance, from the University of Western Australia.