Protecting a Stock Portfolio

Stocks
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Dear Inderes community,

Many times in 2020, we’ve had to admit that we’re in a situation where stock picking is becoming significantly more important. Stock market development is increasingly polarized – e.g., tech is booming, travel and hospitality are plummeting, etc.
It’s clear that in any index, there are excellent companies performing well even in the current situation, available at a discount in some places. Companies that are less susceptible to negative drivers stemming from the coronavirus crisis, such as lockdowns.
Companies whose potential is so vastly greater than any potential macroeconomic slowdown – companies that perform excellently, depending on the negative driver in the stock market.

Owning these quality companies even in an uncertain market situation feels worthwhile. Temporary dips in a company’s development don’t affect the long run, especially when these dips are primarily due to a drop in valuation multiples caused by a broader market decline.
I’ve noticed that more and more people are currently “fully invested” – a tactic that will likely pay off excellently in the long run.

If a portfolio is “full” and bigger market crises are encountered – there’s no need to worry, of course, if the time horizon is long enough. On the other hand, when the market tanks, it would be great to take advantage of already opened buying opportunities – which can further improve returns. However, if the portfolio is full, the situation is trickier – in practice, the options are either sitting on your hands, filling the portfolio even further, or alternatively, methods to gain more buying power in a declining market.

Portfolio hedging can, of course, be done in many ways, with different allocation decisions, negatively correlated stocks, etc. I, for one, have started considering portfolio hedging with a suitable instrument, such as futures or even put options, at least in this market situation.

It’s clear that hedging a portfolio takes away from maximum returns if the markets move upwards. On the other hand, if the stock weighting is large, this is still an “expense” like insurance within an otherwise profitable strategy – and those losses are also deductible.

What kind of hedging methods do forum members use?
It would be meaningful to get a discussion going here about different options.

I, at least on a conceptual level, see a moderately heavily leveraged short instrument as meaningful, for example, which could be around 2% of the portfolio’s value in terms of purchase price. If we’re talking about, say, 10x leverage, the loss is relatively small even if it knocks out – if the portfolio correlates even somewhat with the underlying asset taken, the lost amount is small compared to the development of the rest of the portfolio.
If markets decline, more buying power will be available at some point. Selling it at even somewhat the right time can be a trickier matter – perhaps gradually exiting the “insurance” could be an option.

Opinions, thoughts?

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Rahastot ja ETF:t sijoituskohteina
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Good opening, I’ve pondered this a lot myself, very interested in others’ thoughts!

So far, I’ve only hedged with Nordnet Markets unlimited turbos (S&P500 or Nasdaq shorts), with moderate leverage. This is the best way I’ve found to hedge even with lighter reasons, as there are no brokerage fees for orders over €100, meaning no costs for hedging (excluding built-in product fees) or tax implications from selling shares.

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I don’t know if it counts as hedging, but in practice, I hedge my portfolio by diversifying. Most of my assets are in the stock market, but about 15% are in forestland, which provides security for my investment portfolio. It’s not affected by market fluctuations or the coronavirus, and it also provides reasonably sure and steady returns in the long run.

It works as a hedge for the portfolio, even if it doesn’t make you rich very quickly. As a counterbalance, however, it’s excellent. In addition, since forestland is something tangible, it gives me a little joy when I drive past it.

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Some of mine are in the woods too (heh heh), but otherwise I protect them with traditional means: by diversifying geographically, temporally, by industry, and by quantity.

  • I currently have papers from five countries: Finland, Sweden, Norway, USA, Canada
  • Temporal diversification comes from acquiring throughout the year, instead of single lump sums
  • There are eight different industries: Pharmaceuticals 3, Industry/Automotive 2, Banks 2, REIT 2, Technology 2, Insurance 1, Finance 1, Public Sector 1
  • And the quantity is indeed 14 different instruments at the moment

Perhaps someone could also consider funds and indexes, but somehow they are quite “foreign” to me

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I also own forest, though its share of my portfolio is about 3%, so it doesn’t really smooth out the ride much. My stock portfolio is diversified by industry, geography, and company size (from micro-cap to large-cap). A couple of equity funds also help with diversification.

To be honest, the diversification could be much better; my largest single stock position is over 25% of the entire portfolio.

I have a comfortably sized emergency fund in cash for a rainy day, and it’s completely separate from my investments; I don’t touch it for investment purposes. Otherwise, I don’t really have much cash, so I don’t have the option to move cash into the stock market. If I want to buy something new, I have to trim down existing holdings to free up money for new stocks or funds.

As for hedging, I’ve never used any instruments to protect my portfolio. Using them might make sense if you genuinely understand when the market is at risk of crashing. I don’t have that skill, so I skip hedging.

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Really nice opening! Also, necessary.

In the old man’s opinion, the alpha and omega of everything is the diversification of all assets. Not just the diversification of the portfolio’s contents, but the diversification of all assets. Here’s how the old man does it:

  1. Assets with land, cars, paintings, and other paraphernalia, about 60%. Fixed assets are fixed and won’t change even if the stock market crashes :slight_smile:

  2. Cash in various forms (bank accounts, US dollars, etc.), about 30% :moneybag: :moneybag: :moneybag: Pretty well protected from stock market crashes, and it’s so incredibly nice to dip into when a buying opportunity opens up in stocks (Fortum and Tokmanni just recently).

  3. Stocks, about 10%. An important entertainment component for the old man, YES! And if things go really badly, it can all go and my sleep won’t be much disturbed by it :zzz: :zzz: :zzz:
    But experience has shown that you’d have to be quite a fool to be able to destroy an entire portfolio… So in practice, the portfolio grows at the pace of Mr. Index. It doesn’t win, but it rarely loses either.

Uncle Masse, FA, keep it simple :hugs: :hugs: :hugs:

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I have hedged my portfolio with Nordnet’s short Unlimited Turbos. 10-40% of the portfolio’s value, depending on my own assumed probability of a decline.
I have noticed that hedging the portfolio by selling, say, 30% of the stocks is easier than shorting the same 30% of the portfolio’s value. This is because it is mentally difficult to accept a short that shows a loss in the portfolio if the prices do not fall.

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Forest land here as well, directly, but I’ve found it too difficult with my current schedule, especially regarding maintenance. The portfolio is diversified into various funds (active and passive) as well as direct stocks across different sectors. I’ve been only buying for a good six months, and I bought a little more yesterday. These are for the really long run.

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I was wondering if it’s time to revive this thread. If one wants to stay away from derivatives and try to protect their portfolio from downturns, without going all cash, what options are left for an average investor? Most preferably, I would like to have as broad a sample as possible in such a hedge, without company-specific risk. I would hope for some index-level short product. Leverage or no leverage doesn’t matter, as the stake can be proportioned according to the risk.

For example, can one get some inverse ETF from domestic brokers?

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The intention has also been to bump the thread up from time to time - now perhaps a bit more timely :sweat_smile:.

Nordnet Markets, at least, has reasonably easy products for shorting indices, for example, on the minifutures side. There are several leverage levels available, and no actual trading fees for purchases over €100.

E: I’m not directly aware of inverse ETFs myself.

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If one doesn’t want to use derivatives (and thus high leverage), the short side should ideally account for 50% of the investable assets, or at least as much as the long side. This is if one wants to hedge the entire portfolio, and not just partially.

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So you can’t necessarily get rid of these easily, can you?

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Partial protection would be enough for me, at least. Ideally, I’d like an index-level product either without leverage or with very low leverage that I could hold in my portfolio for a longer period, something like this: SH | Short S&P500 | ProShares

Can anyone using IB say if there are inverse ETFs suitable for this purpose available through them?

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For shorting an index, I’ve only found ETFs with 2x leverage, like “Xtrackers S&P 500 2x Inverse Daily Swap UCITS ETF”. I’ve also used that alongside Nordnet’s Turbos.
In my opinion, it’s not worth hedging the entire portfolio’s value, but rather a suitable percentage of the portfolio, depending on the expected probability of a market downturn.

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How did you acquire that? One could also consider monthly saving in an ETF with increasing contributions for, say, a year :thinking:

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Nordnet also has a corresponding product without leverage: Xtrackers S&P 500 Inverse Daily Swap UCITS ETF 1C (DXS3). Its value is indeed based on swap contracts, so the risk is, of course, that the counterparty might not be able to meet its potential contractual obligations. Because the value is based on swap contracts, it does not perfectly follow true index shorting in the long run, but in principle, it always tries to follow it in the short term.

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Good point about the swap agreement. However, isn’t a fairly large portion of ETFs nowadays synthetic, meaning the ETF itself doesn’t hold stocks and the underlying institution guarantees the return? I see the risk of losing funds as relatively small compared to, for example, certificates or calls/puts, although it always exists. This could be a very interesting savings target/hedge against a market collapse. I’ll have to read the key information document for that when I have more time.

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My US portfolio is in DeGiro, so from there. I mainly use that for short-term hedging, meaning at most a few days. Although, the last time I used Nordnet’s UnlimitedTurbos, which are simpler in a way.

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I’ve sometimes used XACT BEAR and XACT BEAR 2 products, which are available from Nordnet, among other places. The latter has 2x leverage. They inversely track the OMXS30 index. You just need to know how to buy them in time, before a potential downturn starts again someday.

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Yesterday, someone on the forum boasted about moving their portfolio to a zero-interest cash account “because it’s going to crash this year.”

An analyst I respect sees 12-24 months of strong growth ahead, but what happens when the decline begins? There are already too many housing funds, so I’m planning to stash my euros in forest funds for safety.