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Hedging for capital preservation

Investing is not easy in these volatile times. The world is still in the grip of COVID-19, and the outcome of the US presidential election is growing more uncertain by the day. Stock markets generally have been doing well, but it seems everybody I know fears that a big crash is just around the corner. Now, it’s a given that forecasting markets is a mug’s game, but there are now investment products available that can be used as a kind of a hedge.

Hedging a stock portfolio against market falls

On New Year’s Day 2020 an investor with $800,000 in blue-chip Australian shares has a premonition that there may be tough times ahead. He knows it’s important to keep at least three years’ planned expenditure readily accessible, so he will never be forced to dump quality assets at a bad time. He does the numbers and decides an extra $100,000 would be useful to keep as a backstop.

For these examples, I will assume his portfolio’s return matches the All Ordinaries Index.

Option One is to withdraw $100,000 and bank it. The interest will be minuscule, but he has the satisfaction of knowing that there is no chance of capital loss, and the money is there when he needs it.

Option Two is to buy some physical gold. In early January, gold was selling for US$1,519 an ounce (A$2,267) so $100,000 would buy him 46 ounces. The Australian dollar was then worth US$0.67.

Option Three is to try one of the relatively new hedging products, such as BetaShares Australian Equities Strong Bear Hedge Fund, (ASX:BBOZ). It’s like an index fund except that it moves inversely to the All Ordinaries Index. And it has an extra twist – it’s designed to do double whatever the index does. So, if the index rises 5%, BBOZ should fall 10%. In early January the shares were trading at $9.69, so our investor bought 10,320 shares for his $100,000.

Let’s look at the next three months. The All Ords was sitting at 6809 in early January, moved up to 7230 on 21 February and then plunged to 4564 on 23 March. The price of gold also fell – it went to US$1,477, but our investor still did well. Because the Australian dollar had depreciated to US$0.58 his gold was worth A$117,100. This is the benefit of owning assets in US dollars if our dollar falls.

Now let’s look at our new friend BBOZ. Because its value is inversely proportional to the index, it hit a high of $20.15 when the market crashed, and then finished the day at $18.99. The original $100,000 had increased to $196,000. He now has some great choices available to him – he could cash in all the BBOZ shares, bank $100,000 to restore his cash reserve, and spend the other $96,000 to restore his portfolio by buying into a market which has tanked.

As I have said repeatedly, every investment has an upside and a downside. If the market continued rising BBOZ would have fallen at double the rate of the All Ords – but the investor would have achieved substantial capital gain, as well as an income stream, on the remaining $700,000 of the portfolio. BBOZ is a form of insurance, and, as we all know, insurance has a cost.

As a sign of its growing popularity and desire to hedge portfolios, BBOZ experienced the third largest fund inflows among the dozens of listed ETFs in Australia in June 2020, with a net $75 million invested. With the market continuing to rise, the stand-alone investment experience has not been good, but as a hedge, it is expected to lose money when the rest of the portfolio is making gains.

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Other bear products

There are other products available, with more being developed. Two available now, both listed on local exchanges, have the codes BEAR and BBUS. The first one moves similarly to BBOZ, except its performance up or down matches the All Ords without the extra leverage of BBOZ. BBUS tracks the American market, so it may be a reasonable punt for those who think the US will go through turbulent times as the election in November gets nearer.

In addition, ETFS recently launched the Ultra Short Nasdaq 100 Hedge Fund (SNAS), which as the name implies, gives exposure inversely-related to movements in the NASDAQ technology index. Note also that this is leveraged, up to 275%, so can generate considerable losses if the NASDAQ continues to rise. There is a companion long fund (LNAS) which gives leveraged gains when NASDAQ rises.

Also note that these products generally gain their exposure through index futures, which may not perfectly capture changes in the actual physical index.

These are not products for everybody, but if you have a substantial portfolio now, it may be worthwhile talking to your stockbroker or adviser, to see if they are right for your own situation.


Noel Whittaker is the author of Making Money Made Simple and numerous other books on personal finance.

For more information on bear funds, see this recent BetaShares' white paper:

Bear funds: Some questions answered

'Bear funds' are one of the few ways investors can profit from market falls, but it is important to know how they work and the risks involved, including how they relate to movements in the underlying market. Financial advice may assist understanding. Please note that bear funds can incur losses if the market rises, especially the 'geared' versions, and this article does not address the circumstances of any investor.

Ilan Israelstam says financial advisers mostly use the bear ETFs for hedging in client portfolios. “We’re really talking about partial hedging ... We typically find that clients use these as they would use a so-called ‘alternative assets’ allocation, where they’re really thinking about not wanting to be as exposed to equities – alternatives allocations are typically in the range of 5%–10%, and that’s where they would use these products."


November 06, 2020

i understand the concept of insurance and how to protect reverse movement. What i don't understand is using the specific leveraged products like SNAS. If one needs to protect itself against, why not short the listings like NDQ. Doesn't it do the same thing without leverage, lower management fees...

August 07, 2020

What have I just read? Suggesting the average investor should buy BBOZ as a hedge in their portfolio? Risky advice. Over the past 12 months the ASX200 has returned -5% whilst BBOZ has returned -24%. Some hedge. What about 3 years? ASX 11%, BBOZ -52%. Even BetaShares themselves say this shouldn't be held as a long-term investment.

Graham Hand
August 07, 2020

Yes, Andrew, the article stresses the geared nature of BBOZ, and we added the quote from BetaShares describing it as a 'partial hedge' for a small part of a portfolio. In Noel's example, there are $800,000 of equities and $100,000 of BBOZ. We also linked to the BetaShares article on bear funds to give readers more background. Perhaps it's more a product to back a bearish view, but it's finding a market and many advisers are using it.

July 29, 2020

I have just read Noel’s article and the earlier comments dating from as early as David’s July 23 last. I was pleased to see the article as I have current concerns with preservation of personal and SMSF capital in the medium term and Noel correctly covered good examples of a worried investor and 2 approaches available which some of us may have tried. For my part Gold has been a wonderful hedge through Covid19 so why go back to the bear market ETF hedges that cost me plenty in 2 periods of capital preservation concerns post GFC.

Jerome Lander
July 27, 2020

This article does not even mention or cover off the problems with being invested in the bear products for any period of time that comes from their rebalancing problems, meaning that they can be expected to significantly underperform expectations in volatile markets and if held for any period of time (even a period from now until the election as mentioned in the article). It seems to me that they are over-utilised by advisers and investors who don't understand their very significant pitfalls.

July 27, 2020

David L Owen makes a valid point about the difficulties of market-timing where even seasoned experts falter serially.

But this is like telling gambling addicts that that casinos make money for owners not punters. Inverting the certainty of averages which do not apply at the individual level, gamblers have 'faith' that they are an outlier on the way to idle riches. You cannot convert them to atheism!

As behavioural quirks trump rationality, it would be better for those who must invest to opt for low cost (a certainty) and diversification (for smoothing), after working out how much fall in valuation they can endure without losing sanity.

July 26, 2020

Another way to 'insure' against market falls or rises is to buy / sell exchange traded options, depending on the investor's view about particular stocks. Thus, if it is believed a share has gone up in value unsustainably, selling a call option at a price one would be happy to sell would generate a premium; if a stock has fallen too much, buying a put option at a price one would be happy to pay would be a decent strategy to get a foot in. It is possible to do likewise using an ASX index when settlement is in cash rather than in stock (as in the above share-related call / put options).

Subject to awareness about expected dividends and reated franking credits, possible ASX adjustments for corporate actions which alter the number of shares involved and european and american option types, an investor might hedge, or make some money.

It would be useful to have an article on ETOs to supplement Noel's useful article.

David L Owen
July 23, 2020

Whilst Noel W's article on "bear funds" is interesting and thought provoking, perhaps there could be an update article in an upcoming edition of FirstLinks to correctly review the behaviour of this fund over a slightly longer period. As per the article, in early January it was around $9.69 per share. The ASX states that its maximum high over the last 52 weeks was $20.15, although it closed at $18.99 that day. Yesterday, its closing price was $8.13, well below the $9.69 paid by "the investor" back in January 2020.

As a financial planner/adviser of some 31 years and now retired, i have always believed in the commonly held belief that it is "time in the markets" and not "timing" which result in best returns for the average investor. Having read many of Noel's articles over the years, I thought that he advocated this belief as well.



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