New Tools-Better Strategies

In the past year several new investments have come onto the scene that can add a lot of stability to a portfolio while it is working for you.

When we know for sure that the market is going to go up, or even go down, investment decisions become easy.  But, in reality, the market usually goes both up and down, sometimes within the same day.  This instability can drive investors and their advisers crazy.

The investments I’m describing are designed for hedging or reducing portfolio risks.  Hedging involves buying a second investment that moves opposite to the original investment to offset the risk of investment #1 going down in value.  The idea is if #1 goes down, #2 ought to go up.   Mostly, I use “inverse” mutual funds for hedging.

Let’s be clear that I am talking about mutual funds used for hedging, not hedge funds that are the wild west of the investment world right now.  Hedge funds are unregulated private investments available to only very wealthy investors, and often use exotic techniques and investment vehicles.  They have the potential to become a hot bed of scandal due to the lack of regulation in the hedge fund business and the occasional overnight loss of multi-billion dollar pools of money.

What I am talking about is plain old boring mutual funds, but with innovative uses.

Over the past few years, we have occasionally used inverse S&P 500* funds to hedge our risks when the market may be going down.  With this type of fund, if the S&P goes down a buck, the fund should go up a buck or so.   By adding an equal amount of an inverse fund to an account with an index fund, or something similar, the market movement of one cancels out the other making the account “market neutral” or unaffected by the stock market, all without having to sell the original investment.

This is particularly valuable when you have an investment that triggers costs or commissions when it trades, or perhaps imposes a redemption fee to discourage trading.  There are many excellent investments that restrict trading with these mechanisms, forcing investors to be exposed to full market risk to own them.  Hedging can be used to own these investments with lower risk exposure.

But hedges work the other way, too.  They will go down as a market goes up, so they are not suitable for long term holdings, only shorter term trading.

Other than some broad indexes, such as the S&P 500 or the Nasdaq 100*, until recently, we had few hedging choices that did not entail futures and options investing, things that we don’t deal in here due to the high-risk nature of them.

The problem was that these hedges worked well if you wanted to protect a fund that closely mirrored the composition of these indexes, but in practice, most funds act quite differently and were ill suited to be hedged with the early inverse funds.

However, in the past year or two, a heap of new hedging funds have been introduced, giving us the ability to protect a portfolio that wanted to invest in go-go segments of the market such as small company stocks, gold, emerging markets, junk bonds and much more.

Using these new tools, We are in the process of reworking one of our flagship strategies, The Primary Trend System®, which was designed to be out of the market completely when money-flows into the stock markets weaken during the warmer months, to now be at least partially invested all year, making your money work harder than before.

In addition, we will be able to use more investment categories.  Where we would select the two strongest categories out of eight main market segments, we now will have as many as 27 investment categories working at one time, giving us much broader diversification.

Also, we can now consider many great investments that were not available to us before due to trading restrictions.  Despite all these new bells and whistles, my main investment goal is still to reduce the risk you face while being invested.

Now, if we need to protect an investment in a non-tradable fund, we don’t have to take a penalty by selling, we simply can buy an off-setting hedge, becoming as market-neutral as possible, and just wait patiently for the trouble to blow over.

Our back-testing of these changes using historical data is very exciting, and show that we are making a good strategy better and more of an all-weather investment vehicle.

Over the next few weeks we will be making a lot of portfolio moves to incorporate these changes, so you may see a higher than normal level of activity in your account if it is in the moderate risk category (The Primary Trend System® or Core Value System).

If you would like the details on any of this, please call the office at 778-4000 to arrange a time to talk in person or on the phone.

*    The Standard & Poor’s 500 Index and the Nasdaq 100 Index are groups of stocks that are considered representative of the stock market as a whole.  Investors cannot buy these indexes directly.