One of our members in Berlin recently raised the question of how an intelligent investor might go about hedging an equity portfolio. I thought the responses by other Berlin-based investors were quite instructive, so I’d like to share them here.
Philipp Weiland looks to precious metals:
I do no systematic hedging but beginning in the second half of 2014 I established a gold miner position (GDX, GDXJ) that has been growing to about 15% of my portfolio. I did this because I was convinced that this position could stabilize my portfolio during an economic downturn, a new financial crisis or similar occasions.
Another member speaks of cash as well as the drawbacks of short-selling:
I only use cash as a hedge. In the past I have tried a few small short positions, but that didn’t work out as expected. Because I didn’t want to have unlimited risk I only bought long puts. And in that case it is pretty expensive if a short doesn’t work out in the short to medium term. So recognizing that a stock is overvalued isn’t sufficient, or as Keynes said, “The market can stay irrational longer than you can stay solvent”.
Another member of our Berlin-based community talks cash, good businesses, and Fairfax Financial:
We also hold cash (and equivalents) for short term fluctuations, but over long term, the best hedge is having a good portfolio, that will perform well also during bad times. That means being aware of the cyclical nature of some of the industries, avoiding excess leverage, making sure that the companies have decent margin and most importantly, making sure that you are not forced to sell the positions because of recession or contraction in the economy.
As an alternative hedge to cash, we have also bought shares in Fairfax Financial. It’s a portfolio of assets, with insurance at its heart, that has hedged almost 100% of its equity position vs. the index and has also made a massive hedge against deflation ($109 billion). We like it as the insurance business generates cash to pay for the hedges and to make investments whatever the market. The CEO has been a contrarian investor through market downturns. They went big into Greek and Irish assets in the aftermath of the previous crisis. The company is a slight leap of faith for me, as I cannot say that I understand all of its businesses 100%. Its track record of returns has been superb over the last thirty years.
In our interviews with thought-leading fund managers, the topic of hedging occasionally comes up. Here is Phil Ordway, commenting on the decision to hold cash:
Canadian value investor Larry Sarbit comments on why many investors view cash as a negative, and why they’re wrong:
Baupost’s Seth Klarman has also been known to hold a large cash position at times as a way of limiting the downside and creating optionality that could become valuable in a crisis scenario.
On the other side of the coin, famed European value investor Francisco Garcia Parames, who shares many views of the so-called Austrian School of economics, says that he “hates” cash. Parames describes investors who hold cash as creditors of governments. When put in those terms, cash does indeed seem to be an unattractive asset, particularly in light of the massive “quantitative easing” done by central banks.
[full-interview-for-registered h3heading=”Full Conversation with Phil Ordway” introsentence=”Enjoy our exclusive interview with Phil Ordway on the decision to hold cash.” url=”https://www.youtube.com/watch?v=scwtKrz7GkQ”]