He notes that even in good years, sizeable intra-year drawdowns have been normal for equities. Over the past 10 years intra-year drops in the S&P 500 have averaged 16.8%, despite positive returns in seven of these years, he says.
Remain in equities
It is, therefore, advisable for investors to hedge their equity exposure, Preussner argues, in order to remain invested in equities, but add a degree of protection against falling markets.
He says: “For example, hedged equity, or options overlay, strategies are designed to deliver higher risk-adjusted returns than broad-based equity indexes, using options to minimise the impact of market disruptions and downturns, rather than to leverage the portfolio.”
Preussner also sees the merit in strategies incorporating shorting to mitigate potential drawdown. These include funds that combine long positions in companies with strong earnings with short positions in companies facing short-term challenges.
Good, old-fashioned diversification
But Peter Sleep, senior portfolio manager at Seven Investment Management, believes there are better ways to protect a client’s portfolio than buying puts and options; and that is simply through good old-fashioned diversification.
“If you consistently buy the market and buy puts you pretty much end up with a synthetic cash position, or less,” he says. “Buying options is a long-term loss making proposition and buying the market and buying puts is great for brokers, but not so good for your clients.”
He adds: “There are better ways to protect your portfolio in the long term. Diversification of markets and currencies is one way; holding bonds and equities together can help moderate the dips and buying alternative instruments is another way, such as our gold position, or investment in market neutral strategies like CTAs, which we also have.”
