Protecting the portfolio in a bear-market (inverse ETFs?)

[perulv]

tldr: could buying a inverse ETF in the right sector be a good downside protection? If so, what ETF / sector?

 

If we are indeed entering (or in) a bear-market, how would you try to protect your portfolio?

 

If I _knew_ that prices would continue to fall, selling my holdings would make sense. And so would shorting, or simply buying some "bear-ETF".

 

But of course, I have no way of knowing the future direction of the market. I _think_ we might be in the early ish phase of a bear-market, but who knows. And when I try to evaluate my holdings as objectively as I can, I still see high quality companies at low (-er and lower :) ) prices. If the market should rally a bit, I would consider selling some more. But right now selling quality companies at these prices seems to fall into the  "what the wise man does at the start, the fool does at the end" category.

 

Are there other, relatively conservative, ways of preparing for a potential (continued) downturn? I am not looking to "make a killing" by trying to predict anything or "trying to be smart", but soften the fall a bit. And should I be wrong, not lose my shirt.

 

The most straightforward way I can think of right now is to buy some sort of bear (inverse) ETF.  Given that some sectors have been hit much worse than others this year, there might be sectors that have more downside potential left as well?

 

Thoughts, or suggestion for ETFs to look into? If part of the bull-marked has been created by "free money" (re e.g. the Druckenmiller interview mentioned in another post here), are there ETFs that include more of typical leveraged companies? Of course, the market often being efficient, those companies might already have fallen greatly in price  :-\.

 

 

[frommi]

If you are not good at market timing, just don`t do it. When you have found a good strategy where you have an edge than using futures is a good way. I have done it this year and it worked very well.

[Hielko]

I think buying protection for your portfolio should have been done like 3 months ago ;)

[Gregmal]

I think buying protection for your portfolio should have been done like 3 months ago ;)

 

Yup, by the time everyone starts talking about it, it’s already too late.

[SharperDingaan]

Do the pay-off graph, sell 50% of the portfolio, and park the proceeds in T-Bills.

If it goes your way buy that 50% of the portfolio back at lower prices, and keep the difference.

 

It's effective, goes by the name of 'swing trade' or 'synthetic short', and is a dirty word to many on this board.

Use at your own risk.

 

SD

 

 

 

[Cardboard]

Problem is that you called it hedging. Not swing trade nor synthetic short.

 

If you sell out of something or a portion, you no longer have to hedge that position.

 

Cardboard

[Cardboard]

Regarding your question Perulv, I believe that the best way to deal with the current situation is to trade value.

 

So essentially, you look objectively at the price to intrinsic value of each of your holdings, and of other securities available, and try to allocate your capital to the best opportunities. So when things go back to normal, you should see outsized returns.

 

So you may end up selling or reducing cheap holdings for cheaper ones hence trading value. This is no different than what we do or should be doing on a regular basis however, you want to avoid being paralyzed holding the same companies as their stock price keep heading down if you can find something better/cheaper.

 

Regarding so many comments that you will see on this website already or going forward from people who are now near 100% in cash, don't get too overworked about it. If true, they either missed the 9 year bull market fully or partially and they will also miss the eventual rebound. No bell ever rings to tell you to get in or get out of cash.

 

However, it is possible that some were really disciplined and found fewer names over the last few months/years and raised some cash along the way. Although, I do suspect that there would be a really tiny minority of these and again what is going to tell them to invest that cash? This is already a bear market or essentially down 19% or more around the world. Are they going to sit, wait, see all these bargains go by, for a 50% downturn which should happen every 30 years or once every generation?

 

No one can time the top nor bottom. So pain will be felt both ways: you will sell too early or buy too early. It is part of the process.

 

Cardboard

[Gregmal]

Regarding your question Perulv, I believe that the best way to deal with the current situation is to trade value.

 

So essentially, you look objectively at the price to intrinsic value of each of your holdings, and of other securities available, and try to allocate your capital to the best opportunities. So when things go back to normal, you should see outsized returns.

 

So you may end up selling or reducing cheap holdings for cheaper ones hence trading value. This is no different than what we do or should be doing on a regular basis however, you want to avoid being paralyzed holding the same companies as their stock price keep heading down if you can find something better/cheaper.

 

Regarding so many comments that you will see on this website already or going forward from people who are now near 100% in cash, don't get too overworked about it. If true, they either missed the 9 year bull market fully or partially and they will also miss the eventual rebound. No bell ever rings to tell you to get in or get out of cash.

 

However, it is possible that some were really disciplined and found fewer names over the last few months/years and raised some cash along the way. Although, I do suspect that there would be a really tiny minority of these and again what is going to tell them to invest that cash? This is already a bear market or essentially down 19% or more around the world. Are they going to sit, wait, see all these bargains go by, for a 50% downturn which should happen every 30 years or once every generation?

 

No one can time the top nor bottom. So pain will be felt both ways: you will sell too early or buy too early. It is part of the process.

 

Cardboard

 

LOL at the bold and x100. So true.

 

 

[SharperDingaan]

Problem is that you called it hedging. Not swing trade nor synthetic short.

 

If you sell out of something or a portion, you no longer have to hedge that position.

 

Cardboard

 

Cardboard, had you plotted the pay-off graph, you would have found that you have a perfect hedge at 50% of your position.

The short gain on the 50% of your position that you intend to buy back at a lower price, exactly matches the loss on your remaining long portfolio (which is 50% of the size it was), for ALL prices lower than the price you sold your position at. For ALL prices higher than the price you sold your position at, the gain on your remaining long portfolio is exactly offset by the loss incurred on buying in the remaining 50% of your portfolio at a price higher than you sold at. No net change in the value on the way up, AND down - is the definition of a hedge ;)

 

If the investor does NOT intend to repurchase the sold position, it is NOT a swing trade or a synthetic short, and the investment risk is entirely on the investor. Similarly if the investor chooses to invest the sale proceeds in other than a T-Bill, it is NOT a swing trade or a synthetic short.

 

All risks disclosed.

An investor either meets the conditions or doesn't.

His/her choice.

 

 

SD

 

 

 

[no_free_lunch]

I really dislike the inverse etfs, I would stay away.

 

What I do is hold a portion of assets in cash (floating rate etf to be precise) and deploy as things descend (and eat it when things surge).

 

In the past I have used calls in order to keep larger portions of the portfolio in cash.

 

Right now, if you are looking to hedge, you could still look at calls.  Sell some core holdings and buy long dated calls to limit your downside.  Not perfect by any means, you will suffer in a sideways market but pick your poison.

[SHDL]

Put options are the most obvious instrument for this.

 

And +1 on avoiding inverse ETFs.

[KJP]

Agree on avoiding inverse ETFs.  Because of daily rebalancing, they will not match the inverse of the performance of the index over time.

[John Hjorth]

Per,

 

Also, ref. Cardboard's post #7 : Joel Stevens - Austin Value Capital [November 15^th 2014] : Why hold cash?.

 

[Joel is our fellow CoBF member racemize.]

 

Edit:

 

Fixed second link.

[NewbieD]

Inverse ETFs should only be used for short-term ideas - the more leverage the shorter.

 

Had a colleague who invested in the JNUG junior gold miners 3x levered ETF. I didn't manage to convince him it was a bad idea even after showing the JDST 3x inverse overlayed on top, showing both down 90%+ over a longer term graph.

 

So many other options. I have used moving to cash, fixed income and buying puts. Puts is probably too late as said due to vol levels so if you want to protect further downside you could consider put spreads to reduce risk of vol normalising to your option value. Makes sense if you believe in some limited further downside. Futures can offer a linear hedge to index exposure.

 

Moving a portion of portfolio into merger arbitrage - not too experienced in this area but it seems risk premiums are increasing lately (Swedish market) - not sure the risk for deals falling through have increased as much. Guess this could be mostly driven by liquidity?

 

[perulv]

Thanks for all the valuable advice and thoughts. I have nothing to add, and will probably spend the next days reading and thinking, rather than doing any trades.

[Fearful Optimism]

Totally agree with not owning inverse ETFs to protect.

 

A better strategy would be to short the leveraged long ETFs.  If I am looking at this correctly on IB, it appears you are getting paid to short some of them (UPRO, TQQQ).