23 October 2016
The Japanese yen and gold could be great investment options amid heightened volatility in the market. Photo: Bloomberg
The Japanese yen and gold could be great investment options amid heightened volatility in the market. Photo: Bloomberg

Six strategies to protect your portfolio

Global stock markets have been disappointing since the start of the year.

Morgan Stanley expects the Hang Seng Index to reach a low of 16,500 points, and the H-share index to hit a trough of 7,300 points. Oil price is likely to bottom out in the range of US$20 to US$30 a barrel.

The renminbi’s depreciation also unnerved global investors, who used to be bullish in the Chinese currency. Its weakness was due to capital outflow. China’s foreign exchange reserves dropped by a record US$107.9 billion in December.

The impact has rippled through currencies, equities and other asset classes.

How should investors position themselves in such a volatile market? How should they protect their portfolio?

1) Cash is king. Wait until the market bottoms out. Enter the market when the uptrend has been confirmed, even though prices have become more expensive.

2) Take advantage of convertible bonds. Investors who are looking at the long term and comfortable with low dividends in the short term can take advantage of convertible bonds. They can convert to shares at the right time. Warren Buffett bought convertible bonds of Goldman Sachs in 2008, which allowed him to move actively or defensively.

3) Buy insurance.  Investors can use options or futures to hedge against their investment portfolios. They can decide their hedging position according to their risk appetite and the beta of their portfolios.

Such hedges could help serve as a buffer when the market slides, although they could reduce returns during a market rally. However, it’s much easier and convenient to buy equity futures or options with leverage. It’s a good choice when investing in volatile markets.

They can also buy Volatility Index (VIX) futures, which reflect the volatility of the S&P index. Or they can buy VIX exchange-traded funds or exchange-traded notes listed in the United States. The VIX is up 25 this year amid increased market volatility. As a result, the VIX ETF has soared around 20 percent.

The VIX index has hovered around 20 for most of the time, after peaking at nearly 90 during the 2008 financial crisis.

One European hedge fund used to invest in the index through its Volatility Arbitrage Fund. Many investors have bet on the fund as an insurance. The fund could generate 40 to 50 percent return during financial turmoils, or even double or triple your investment in a financial tsunami.

4) Buy falling ETFs. Our fund invested in an oil ETF and doubled our investment in 2014. The oil ETF jumped another 104 percent last year, and is up 34.65 percent this year.

This ETF could surge another 50 or 100 percent if the oil price tumbles to US$20 per barrel.

However, investors should be very careful at the moment since the oil market could turn around anytime soon. In this case, they should try to lock up profit or limit losses. They could get ready to switch to other ETFs that would benefit from rising oil price, or buy energy stocks or funds.

5) Closely watch gold ETFs and gold mining stocks.The US rate hike is set to weigh on the gold price. However, if the Federal Reserve fails to deliver further rate increases as expected — as a result of economic difficulties elsewhere — the gold price may rebound strongly. Geopolitical risks in the Middle East will also boost the precious metal.

6) Japanese yen and stocks. The Japanese yen has risen to 117.7 against the US dollar this year. Many investors have used the yen or the dollar as safe-haven assets after the financial crisis. Investors should hold yen and sell Japanese stocks if there is another financial crisis. A weaker yen has helped Japan attract a great number of foreign tourists. However, it may have done little to spur domestic consumption.

This article appeared in the Hong Kong Economic Journal on Jan. 14.

Translation by Julie Zhu

[Chinese version 中文版]

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Founder and Managing Director of Pegasus Fund Managers Ltd.

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