Date
28 July 2017
Despite such developments as the US Federal Reserve's decision to shrink its balance sheet and the North Korea crisis, stock markets have continued to do well. Photo: Reuters
Despite such developments as the US Federal Reserve's decision to shrink its balance sheet and the North Korea crisis, stock markets have continued to do well. Photo: Reuters

Defense is key for active funds to beat index

Although exchange traded index funds have continued to gain traction, these products have weaknesses, too.

One is their inevitable decline during market downturns. This is so because index funds, by definition, tracks the index, rain or shine.

Being able to guard the value of the portfolio during a bearish phase of the market is crucial for an actively managed fund to beat index funds. Another would be the ability to pick the right stocks.

In fact, for investors in actively managed funds, the fund manager’s ability to protect the downside is sometimes more important than maximizing the upside.

There have been a number of developments, such as the US Federal Reserve’s decision to shrink its balance sheet, the North Korea crisis and the weaker Hong Kong dollar, that might bring negative impacts, but stock markets have continued to do well.

While acknowledging the risk of a sudden reversal, I am holding on to my long positions at the moment as long as the uptrend remains intact.

Nevertheless, as a form of insurance, I will be buying some out-of-money put options on a monthly basis to shield against potential loss from an unexpected downturn.

Sentiment usually takes time to undergo a major shift, especially when the market is dominated by individuals.

But with the market turnover failing to rise in line with the share prices, the current market appears to be dominated by professionals, who are more likely to change their minds abruptly as the market evolves.

That means if the market comes down, it can fall hard and fast and it won’t be easy to get out quickly enough, thus the need to use options as an insurance.

This article appeared in the Hong Kong Economic Journal on May 2

Translation by Julie Zhu

[Chinese version 中文版]

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RT/CG

Director, Asset Management at Ample Capital Limited.

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