There are plenty of ways that you can hurt a man and bring him to the ground.
You can beat him, you can cheat him, you can treat him bad and leave him when he’s down.
Queen – Another One Bites The Dust
Over the last 12 months, most efforts to hedge against U.S. stock risk have proven to been an exercise in disappointment. And that’s if you merely chose milder forms of hedging, such as losing dollars with numerous put options or losing opportunity with excess cash. If you boarded the bear train with funds like ProShares UltraShort S&P 500 (SDS) or ProShares UltraShort NASDAQ 100 QQQ (QID) – if you did not have an exit strategy for being on the wrong side of an ever-appreciating stock market – the destruction to your portfolio may have humbled and overwhelmed. Year-to-date, SDS has shed approximately 25%.
However, hedging against stock risk does not have to be an exercise in dust-ingesting humiliation. Problems arise when one chooses to shoot for the moon on a gamble, such as “shorting” or employing inverse leverage with daily compounding inverse ETFs. Problems also arise when one looks to a singular asset for all the answers. Investment-grade U.S. treasuries may be great, unless you’ve chosen a single asset with an unfavorable duration or poor liquidity. Treasuries may also be limiting in the fact that sovereign debt from other nations often provide an effective hedge without the over-reliance on U.S. debt alone. Cash can be king in troubled times for stocks, though it often leaves an investor feeling stuck like a deer in the headlights, searching for a time to “get back in.” Similarly, if the cash is represented by the almighty buck, it ignored the effectiveness of a variety of global currencies with historically negative correlations with stocks.
In essence, if you peruse the Internet for ways to hedge against a downside stock slide, you are unlikely to discover a diversified basket. Instead, you will probably be told the same old dance and song. “Go short.” Buy bonds. Grab some put options. Hide in cash. Heck, you may even be advised to do nothing at all, since most financial professionals carelessly fall back on a “buy-n-hold-hope” approach.
Keep in mind, shorting positions or purchasing leveraged inverse funds does not simply involve the risk of an accurate prediction. It typically requires an investor to become an extremely active trader. Meanwhile, put options can be expensive when establishing multiple portfolio positions, not to mention that they have limited lifespans. And once again, neither cash nor U.S. bonds may properly diversify one’s hedge, since both are denominated in a single currency.
Each of these hedging approaches do have value, or you would not read about them in your Google searches. What’s missing is the fact that none may be suitable on its own. And that’s why one of the most important new developments in asset management is multi-asset stock hedging.