Portfolio manager Keith Richards sees some upside for the stock markets from here, but watch out come September or October.
“One of the cycles that I’m absolutely sure is going to come true is a pretty sharp selloff after a short-term rebound over the summer,” said Mr. Richards, who runs portfolios for high net-worth investors at ValueTrend Wealth Management, which is affiliated with WorldSource Securities.
Step one to prepare was some selling on April 27 that turned a significant portion of his stock holdings into cash. Step two will be to buy an inverse exchange-traded fund that he expects to protect his clients as the stock markets fall.
“There will be a point where we’ll want to hedge the portfolio more aggressively, rather than just holding cash,” he said.
Mr. Richards plans to buy the Horizons BetaPro S&P/TSX 60 Inverse ETF HIX-T, part of a family of seven inverse ETFs. Think of these products as tamer – though certainly not benign – versions of the leveraged ETFs that have generated some controversy because of their unpredictable behaviour. They’re also a simple and cost-competitive alternative to traditional forms of down-market protection like short selling and using put options.
Leveraged ETFs give you two times the up or down move of an underlying index or commodity, depending on whether you buy the bull or bear version. Inverse ETFs are designed only for falling markets, and they reflect daily index moves on a 1:1 basis.
Mr. Richards said he’s only used leveraged ETFs on one occasion, and that was at a client’s specific request. “I don’t have the cojones to trade them myself,” he joked, He’s not the only money manager to find single inverse ETFs more user-friendly than their leveraged counterparts.
“They’re easier to get your hands around as a concept,” said John Stephenson, senior vice-president and portfolio manager with First Asset Funds Inc. “They’re generally less volatile – you’re reducing the risk.”
Even so, inverse ETFs are strictly for experienced, hands-on investors who feel comfortable with the idea of buying, monitoring and selling when required. They are not a magic charm you install in a portfolio for endless protection from stock market losses.
Both inverse and leveraged ETFs use financial instruments called derivatives to produce their returns, and that presents a unique risk for investors. In certain situations, you can end up with returns that look nothing like what you’d expect given the path of the underlying index or commodity. In fact, you can lose money with inverse ETFs even when the markets fall.
