Strategies of Portfolio Protection

SmartStops commentary: Below are some ideas for using ETFs to hedge a portfolio. The list of ETFs that go short is worth saving.

Investment Portfolio Protection

Strategies of Portfolio Protection

http://knol.google.com/k/samuel-gap/investment-portfolio-protection/7x625mtk3b8m/11#

These days the question of how to protect the investment portfolio becomes essential and central.

Most of us have lost some (or big) money as result of the Subprime crisis. Since this crisis crossed borders and sectors most of the individuals’ and corporations’ investment portfolios had to suffer. Even cases of sophisticated and wise investors could not show positive returns on the portfolios as the market trends and physiology around the world were negative. In such days the question of how to protect the investment portfolio becomes essential and central. Obviously the ultimate way to protect the portfolio is to sell it and hold cash only – however this is only a theoretical solution since investors expect some returns on their money and selling the entire portfolio can also cause huge transaction costs.

Portfolio Protection – Introduction

In the last decades the financial markets evolved to enable professional investors to protect their investments by short and hedge position. The simple way of protection is by purchasing PUT options or Future contracts betting the decrease of a specific company, sector or market. These instruments are costly as they reflect the option and time price in the option price. These instruments also require the investor not only to bet on the direction of the share or market (increase or decrease) but also to bet the timeframe since options and contracts expire at a certain date. Another instrument which requires high expertise is short selling of specific shares covered by stock lending arrangement. The latter enables the investor to sell shares that he does not own and buy later buyback the shares at a lower price (in case the bet succeeds and the share price falls). This short selling requires complicated procedures and high sophistication and usually cannot be performed by an ordinary individual. Therefore, the next step of the market evolvement was of professional fund managers to offer the public many types of mutual funds, hedge funds or private fund that manage short positions on specific markets or sectors. Recently, some fund managers also offer equity traded funds which aim at inverse exposure to specific sectors or indexes. These ETFs are simple and quick way to protect a portfolio and the transaction (buy/sell) is handled like any other listed share in the market.

Thus, an interesting protection structure which investor may choose is to hold shares and funds of markets and sectors he believes will perform well (“to go long”) and to purchase short ETFs or funds in markets or sectors what he believes will underperform (“to go short”).

Such a structure will enable you to be more balanced on your entire portfolio if markets will continue falling crossing all sectors and markets (in such case your short funds will make some gains), but will still allow you to bet on specific markets and sectors you believe will rise or fall. When buying short ETFs important to notice that some of them are leveraged and volatile promising the investor “twice the inverse daily return of the index”.

ETFs Short Funds:

Below are some examples of “bear market” (short position) ETFs traded in the US markets-

UltraShort SmallCap600 ProShares (US symbol: SDD) which goal is to “correspond to twice the inverse of the daily performance of the S&P SmallCap 600 index”. http://finance.yahoo.com/q?s=sdd

Short Russell2000 (US symbol: RWM) which goal is to “correspond to the inverse of the daily performance of the Russell 2000 index”. http://finance.yahoo.com/q?s=rwm

UltraShort Industrials ProShares (US symbol: SIJ) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Industrials index”. http://finance.yahoo.com/q?s=sij

UltraShort Consumer Services ProShares (US symbol: SCC) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Consumer Services index”. http://finance.yahoo.com/q?s=scc

UltraShort MSCI Emerging Mrkts ProShares (US symbol: EEV) which goal is to “correspond to twice the inverse of the daily performance of the MSCI Emerging Markets index”. http://finance.yahoo.com/q?s=eev

UltraShort FTSE/Xinhua China 25 Proshare (US Symbol: FXP) which goal is to “correspond to twice the inverse of the daily performance of the FTSE/Xinhua China 25 index”. http://finance.yahoo.com/q?s=fxp

UltraShort Financials ProShares (US Symbol: SKF) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Financials index”. http://finance.yahoo.com/q?s=skf

UltraShort Oil & Gas ProShares (US Symbol: DUG) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Oil & Gas index”. http://finance.yahoo.com/q?s=dug

UltraShort Technology ProShares (US Symbol: REW) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Technology index”. http://finance.yahoo.com/q?s=rew

UltraShort MSCI Japan Proshares (US Symbol: EWV) which goal is to “correspond to twice the inverse of the daily performance of the MSCI Japan index”. http://finance.yahoo.com/q?s=ewv

UltraShort Utilities ProShares (US Symbol: SDP) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Utilities index”. http://finance.yahoo.com/q?s=sdp

UltraShort Semiconductor ProShares (US Symbol: SSG) which goal is to “correspond to twice the inverse of the daily performance of the Dow Jones U.S. Semiconductor index”. http://finance.yahoo.com/q?s=ssg

Disclaimer:

The information contained in this article and from any communication related to this article is for information purposes only. The author does not hold itself out as providing any legal, financial or other advice, and is not authorized to do so. The author also does not make any recommendation or endorsement as to any investment, advisor or other service or product or to any material submitted by third parties or linked to this article. In addition, the article does not offer any advice regarding the nature, potential value or suitability of any particular investment, security or investment strategy. The material in this article does not constitute advice and you should not rely on any material in this article to make (or refrain from making) any decision or take (or refrain from making) any action.