Do you hedge?
If yes, what instrument are your using and why?
TLT, Short IWM, SPY or QQQ, or options, futures short etc.
Thank you and Best Regards
Andreas
After years of messing around with shorting and inverse ETF’s I have come to the conclusion the IEF / TLT are the only practical hedges. Government bonds are the only instrument with an overall positive expectancy and a high negative correlation to equities in times of distress. They are not perfect, but they are better than the alternatives.
Alpha Architect just put out an interesting article on the subject. See Crisis Alpha.
IEF / TLT have worked very well since 1987 during falling interest rates. They have worked before that too but not as well. I’ve posted about this before.
I have tested fixed allocations of stocks / gov’t bonds across many countries. I varied the fixed allocations between stock/government bonds of one country at a time for the years that I had data. (i.e.: US Stocks/US Treasuries, Australian Stocks/Australian Government bonds etc.) Allocating at least a 15% fixed allocation to government bonds was always better over the long term than 100% equities in every market I tried.
Personally for a hedge I use:
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My Bond Hedge system. It probably wont do as well as the backtest indicates when long term rates are rising (which has been happening already and may continue to happen to some degree for the next ten plus years). It also will not catch sudden crashes like 1987. Still, at the risk of sounding like an advertisement, it combines some of the benefits of treasuries with some of the benefits of trend-following. It’s best years were during volatility; 2008, 2009 and 2011 – precisely when it was needed most.
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I also use a market timing system for 1/3 of my portfolio. When the signal goes on, I go from 70/30 stocks/bonds to 70/30/-25; stocks/bonds/about 25% short the stock market overall. This gives me a net long exposure of between 70%+ to 45% depending on market conditions.
My market timing system is proprietary and based on a composite of fundamentals. This type of system is not not meant to protect you from every market correction; it is meant to sidestep the biggest major market crashes. In fact the greater the crash the more likely that the signal will kick in.
Chaim
Andreas thanks for asking I am very interested in this topic,
My own investments are about 40% bonds (TLT,IEF) and 60% stocks this can fluctuate based on the market timing rules. I sometimes use SH. But after you posted this “https://realvisiontv.com/videos/5491c9fde31d53eb75ffe8b2” and based on the comments by other users I started looking for a better Hedge.
What I found was EUM is good Hedge. When you add it to a book at around 12-15% you lower the drawdown and increase the sharpe ratio. Unfourtunatly data is only available since late 2007. If international markets continue to be under pressure then EUM is what I will use but my crystal ball is broken.
Does anyone have a better Hedge other then EUM that they are willing to share? What is the criteria for a good Hedge other than lower drawdown and higher sharp ratio? Is betting on international markets falling more risky than Hedging with SH?
Regards,
Mark V.
Mark,
EUM loses money over the long term; perhaps about 6%/year + ETF fees and costs.
Besides, the historical period is different than the future, for example China is transforming it’s economy like Japan transformed from the 1950’s, so China in 2016 is not the same China as 2007.
Chaim
Chaim,
SH loses money also but it comes down to what do you want your Hedge to do? Lots of R2G are using SH and have good returns. What are the most important goals of a Hedge in combination with the book? For me it’s low drawdown and high sharp ratio. It seems the best way to do this is a combination of uncorrelated assets in a book. A balance of Stocks, bonds and Shorting certain markets is producing the best results for me. Is there are better way?
Mark V.
Due to the nature of bear market trading you won’t want own EUM long term, only in the short and intermediate term.
We’ve added CHAD to portfolios this morning
Long CHAD and EUM
Mark,
I see. Still, comparing EUM to SH during the 2007-2015 period is not indicative going forward for the following reasons:
A. SPY has had a great run during these past seven years. There is mean reversion for seven year returns.
B. Long term (over the next ten years or so) forward returns of emerging markets will probably be much more than SPY. This is because they are growing faster and are selling for cheaper.
C. Many emerging markets have been hit by the commodities crash while the US has gained.
D. The strengthening dollar has also pushed down emerging markets. I don’t know if this strengthening will continue.
E. There is a shift underway in the “emerging” economies. Emerging stocks have traditionally made money by selling to “developed” economies. This meant that any time the US economy went down, it took those countries down with it. As the economies of the “emerging” countries grow, the emerging stocks are getting more and more sales internally. This means that US recessions will affect “emerging” countries less and less as time goes on. (In a global economy there will naturally still be some strong ripple effects; just not as strong as it was).
I am interested in your thoughts. Do have a theory why EUM should continue to be a good hedge?
Chaim
[quote]
Due to the nature of bear market trading you won’t want own EUM long term, only in the short and intermediate term.
We’ve added CHAD to portfolios this morning
Long CHAD and EUM
[/quote]Brad,
I could see myself hedging with EUM under the proper circumstances, but CHAD? Owning CHAD means fighting against the Chinese government. If the Chinese leaders get desperate they can and will take desperate measures such as artificially propping up Chinese stock prices without giving us any notice.
Chaim
I “hedge” through diversification of my portfolio:
35% U.S. Equities (P123 Book with ~80 stocks)
10% Int’l Equities (Developed, Emerging Markets)
10% REIT (U.S. and Int’l)
10% Credit (High Yield Bonds, Emerging Market Debt)
10% Alternatives (Hedge Fund Replication, Managed Futures)
5% Commodities
20% Total Bond Index
I would like to allocate more to my P123 equity strategy, but ran out of room in my Roth IRA.
In my taxable account, I’ve also invested about 20% of my equity portfolio in a P123 short strategy of ~40 stocks, which has performed as expected so far.
I hear ya Chaim and agree with you, who knows what they’ll do? But it’s undeniably a popped bubble and I’ve only taken on a small position. I’ve been in Tbonds for over a month so I can afford a flyer
And, the EUM is a very crowded trade so I wanted something different
Chaim,
I picked EUM based on I think International markets will go down in the short term. When I added it to my books it reduced drawdown and increased the sharp ratio. Much better then SH. I am sure there is a better strategy and would love to hear other peoples ideas.
Mark V.
How about this… 50% equities / 25% FXY (Yen) / 25% UUP (Bullish dollar)
https://www.portfolio123.com/app/screen/summary/145717
Rebalance every 3 months.
The currencies cut out most of the drawdown. Substitute your p123 models for the equity etfs.
Steve
China PMI 47.1
Mark,
The best hedge is one that has negative correlation to the stock market. During the 70’s and early 80’s gold was negatively correlated. Since 1987 it was treasuries that went up when the market went down.
My favorite hedging strategy (which I don’t yet have the technology for) is to dynamically change allocations of asset classes based on recent correlations and volatility (and possibly momentum).
Chaim
VWO (ETF on MSCI Emerging Markets) is shortable…
[quote]
[quote]
Due to the nature of bear market trading you won’t want own EUM long term, only in the short and intermediate term.
We’ve added CHAD to portfolios this morning
Long CHAD and EUM
[/quote]Brad,
I could see myself hedging with EUM under the proper circumstances, but CHAD? Owning CHAD means fighting against the Chinese government. If the Chinese leaders get desperate they can and will take desperate measures such as artificially propping up Chinese stock prices without giving us any notice.
Chaim
[/quote]"China’s government intervened to boost the stock market Thursday, according to people familiar with the matter.
China wants the market to stabilize ahead of a Sept. 3 military parade celebrating the World War II victory over Japan, said the people, who asked not to be identified because the move wasn’t publicly announced. The government bought blue-chip stocks, according to one of the people.
The Shanghai Composite Index swung from a loss of 0.7 percent to rally 5.3 percent in the last hour of trading, ending its steepest five-day rout since 1996. The China Securities Regulatory Commission didn’t immediately respond to a faxed request for comment."
The complete article is here .
Hi Chipper, is you post intended for me? To clarify I sold my CHAD and EUM positions on Mondays swoon lower and made about 12 points on CHAD and 4 on EUM. Its rare for me to own a short trade for longer than a few weeks due to the huge volatility that exists in bear markets. When it comes to bear market trading (I’ve traded in every bear market since 1982) I don’t rely on P123. I realize trading like this this is counter-intuitive to everyone here on P123 but it works very well for me.
“The nature of bear market trading” means to me that you’ll experience violent counter trends to the upside in a bear market, just as we’re seeing now.
It doesn’t matter to me what the Chinese government says they cannot eliminate the business cycle but they certainly can prop their markets up for periods of time.
Hi Brad,
I was aware that you sold them. Maybe one day you can teach us how you do it.
For people like me who don’t know how to time these things I don’t want to be caught taking on the Chinese government.
Another thing, according to that article, I would mark Sep 3 and 4 on the calendar. Once the parade is over who knows what will happen in China.