Protecting your portfolio against a downturn
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With views mixed on whether the current bull market has much left to run, wealth advisors say investors need to position their portfolios to insulate against a market shock should it come, which includes holding more cash than usual and alternative investments that can withstand shocks.
Many experts are pointing to a correction in bank shares, especially if the property market should come off the boil. Interest rate rises in the US could eventually feed back into Australia, straining all markets.
According to financial planner Andrew Lord, a director at Sherbrook Private, any interest rate increases will have a magnified effect on share valuations.
"This is at a point in the cycle when banks are most at risk of a property correction and we are seeing increased impairment and default rates," says Lord, who like the Future Fund, recommends a relatively high exposure to alternative investments.
"With such a low running yield on shares (about 4.5 per cent grossed up), there looks to be limited upside left and considerable downside, so investors should also be thinking about increasing their cash reserves in the hope of buying assets below their fair value," says Lord, who now recommends clients hold around 10 to 20 per cent of their portfolios in cash.
"Protecting against market corrections, we have maintained a 35 per cent exposure to alternative funds that have a shorting capability to capitalise on those mispriced companies that are now expensive."
Another option for portfolio protection is through the use of defensive exchange-traded funds (ETFs).
"Significant geopolitical and economic events this year continue to contribute to ongoing market volatility, therefore it is important for investors to consider ways to protect their portfolios in the event of a market downturn," says Arian Neiron, managing director of VanEck Australia.
"ETFs can provide effective ways to protect a portfolio against uncertain markets and mitigate downside risk. Gold is an effective hedge against uncertainty and fears of market weakness.
"Gold rallied above $1,200 per ounce in February this year and has rallied again since the US rate hike in March ... A higher gold price largely correlates to investors' increasing unease about the global financial system."
Neiron recommends gold miners' ETFs rather than a straight gold ETF, since gold miners pay dividends instead of incurring holding costs. VanEck's Gold Miners ETF (ASX: GDX) gives investors instant access to a diversified portfolio of over 50 global gold mining companies in a single ASX trade.
In terms of other assets, infrastructure securities are considered alternative investments with a low correlation to traditional asset classes, says Neiron.
VanEck's FTSE Global Infrastructure (Hedged) ETF (ASX: IFRA) provides investors with access to a portfolio of over 150 of the world's largest global infrastructure securities in a single ASX trade.
Another option for those who think the market is headed down is "short" ETFs such as the BetaShares Australian Equities Strong Bear (ASX: BBOZ) and the BetaShares Australian Equities Bear Hedge Funds (ASX: BEAR).
With the former, a 1 per cent fall in the Australian share market on a given day can generally be expected to deliver a 2.0 per cent to 2.75 per cent increase in the value of this ETF. But if the market goes up, your ETF will fall in value by that same amount.
On a slightly less defensive note, the BetaShares Australian Equity Bear Hedge Fund will also rise if the market falls; a 1 per cent drop in the Australian share market on a given day can generally be expected to deliver a 0.9 per cent to 1.1 per cent increase in the value of the fund (and vice versa).
These ETFs offer the convenience of being able to short the market while avoiding the complications and costs of more expensive derivatives.
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Nicki Bourlioufas is a Morningstar contributor. This is a financial news article to be used for non-commercial purposes and is not intended to provide financial advice of any kind. Opinions expressed herein are subject to change without notice and may differ or be contrary to the opinions or recommendations of Morningstar as a result of using different assumptions and criteria.
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