Defending a portfolio in falling markets
With equity markets worldwide looking a little shaky during the past few weeks, investment advisers say it is a good idea to have a little insurance built into a portfolio. That means moving away from an investment strategy solely based on the idea that stocks or bonds are going to rise, otherwise known as a long-only strategy. Instead, advisers say, to offset risk, try betting a small portion that stocks will go down - a strategy usually referred to as a short position.
'For people who are managing portfolios or managing their own portfolios, they should be moving away from mutual funds that are long only and equities which are long only,' says Peter Hatz, associate director of the Shanghai office of Formon and Associates.
'I think the ability to select long over the next year is going to be very difficult.'
Short selling a stock is quite common in London and New York; Hong Kong banned the practice as part of the financial sector reforms in the aftermath of the Asian financial crisis. At its most basic, shorting a small portion of stock holdings gives investors a little more time to rework their investment strategies - even time to exit the market.
To prove his point, Mr Hatz draws the example of an investor who holds a large position in a UK telecom company. If the stock suddenly nose-dived 10 per cent, the shorting strategy would soften the loss, leaving the investor closer to his initial starting capital. At that point an investor may want to sell a stock on weak footing or otherwise revise strategy.
'Once you are at that break-even point then it is for you to decide, but at least you haven't made a loss,' he says. If the market moves upwards, the shorting strategy would cripple but not eliminate gains, because only a fraction is bet against the total stock holding.
He says selling down an equity position, or simply holding cash, is not a good option owing to the paltry interest rates on bank deposits.
For alternative hedging strategies in Hong Kong, it is possible to look towards the options market, says Steve Kelsey of Interactive Brokers Group. Most of the larger shares offer call options, which can be used to offset the risk of falling share prices in much the same way as short-selling in foreign markets. For non-professional investors, he admits, the learning curve can be a struggle. He recommends speaking with a local broker for assistance in setting up an offsetting risk structure. A dose of patience may help in the non-customer-friendly world of local brokers, he says.
Using options to reduce risk has several advantages. Investors who sell down their shares with the intention of repurchasing at cheaper levels later run the risk of hefty broker fees and bid/ask spreads that can add 1 per cent to the transaction cost. The strategy also assumes the ability to time the market. 'When trying to time the bottom, very few investors get it right,' he says.
Perhaps the easiest strategy for the layman, says Mr Hatz, is to invest through funds that have the ability to go long and short. This leaves the technical worries up to the pros, and provides security making it easier to sleep at night. Many of the big fund houses offer long/short strategies, so switching should be relatively easy.
