Daily Gains Letter

Don’t Get Lured in by Rising Markets; Use This Hedge Fund Strategy and Protect Your Portfolio

By for Daily Gains Letter | Apr 15, 2013

















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When it comes to the world of investing, it is often said that a rising tide raises all boats. The idea behind this is very simple: if a stock market, or any other market for that matter, is experiencing a bull run, an investor who is bullish will make money. A good example of this phenomenon would be the “dot-com” period, when investors made money on whatever they bought—even the companies that didn’t even have any revenues.

Unfortunately, all parties must end. The dot-com bull run ended, as well, with the NASDAQ falling from its all-time high of 5,000 to below 1,200 in the period from 2000 to 2002.

Warren Buffett explained this phenomenon best. He said, “Only when the tide goes out do you discover who’s been swimming naked.” (Source: Brainy Quotes, last accessed April 11, 2103.)

Those who continued to believe the NASDAQ would make a comeback were wrong. The index is still trading below its all-time high 13 years later, and some of the well-known companies during that period are no longer even in business today.

Making money when the overall market is headed upward can be easy if investors follow the market, but keeping those gains is the most difficult task.

With all this said, how can an investor make their portfolio immune to the market’s swings to save what they have?

To make sure your portfolio doesn’t swing with the overall market, you have to make sure the correlation between your portfolio and the market is zero (an ideal situation that’s rare to see) or close it. On one hand, you can do this by spreading your savings across different asset classes and by diversifying. On the other hand, you may want to employ alternative strategies to grow your portfolio.

Consider the QuantShares US Market Neutral Value (NYSEArca/CHEP) exchange-traded fund (ETF). Market performance for this ETF doesn’t matter. (Source: QuantShares web site, last accessed April 11, 2013.)

Unlike many ETFs out there, this fund provides a chance for individual investors to be involved in a strategy that was once mainly available to hedge fund investors—the market neutral strategy. At the very core, this strategy of investing provides investors with a very low correlation to the overall market by hedging—staying long and short.

The fund will provide positive returns to investors if the 200 companies it buys (longs) outperform the 200 companies it shorts—regardless of market condition. In contrast, the fund will yield a negative return when the long positions underperform the short positions.

Keeping all this in mind, using alternative investment strategies can sometimes cost much more. This QuantShares ETF has a net expense ratio of 1.5%, for example—which is much higher than an ETF like the SPDR S&P 500 (NYSEArca/SPY).

Similarly, even though the investor is immune to the overall market movement, if the holdings in the fund don’t perform as perceived, then an investor could face losses. To see your portfolio grow over time, you have to make sure not to put all your eggs in one basket—you still have to work to minimize your portfolio’s risk.

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