Feeling Defensive?
While I’m of the camp that believes that the subprime meltdown will be relatively contained and that the economy and the stock markets will get through this current correction without a collapse in prices, there’s really no way to know for sure. The last few weeks may triggered profit taking or stop losses in your portfolio and you may be sitting around with a bunch of cash wondering what to do next. With money market accounts and CDs providing rather low returns, it seems that its time to get some skin back in the game. So, let’s talk defensive strategies.
We’ve already discussed a few interesting defensive strategies which can be employed by the use of ETFs – hedging, indexing, and asset allocation. Basically, the goal is to diversify your risk exposure and try to limit the effects of event, asset class and industry specific risks.
Generally, if your domestic market is falling, the goal is to increase your allocations in the most uncorrelated or as negatively correlated securities as possible. This will help your portfolio to weather the storm in the intermediate term by decreasing volatility within your own portfolio and allowing you to be patient with the securities within your domestic market that you decided to hold on to.
But, where exactly should we be looking if we’re going to attempt a more diversified allocation? Well, for one we could look globally. Yes, many markets around the world are highly volatile and likely not the best for a defensive portfolio. But, there are also many undervalued, under appreciated economies which provide steady, consistent returns. Look towards modernized countries that have rather mature industries – Australia, The Netherlands, Sweden, and Japan are great examples. For a great article highlighting some ETFs which are particularly interesting, read this article from SeekingAlpha. These investments are particularly interesting as the growth of ETFs and increased international investing has turned these countries’ markets into a sort of “global value” play. You can be sure, as people realize that prices have been bid up to ridiculous levels in popular, high-flying emergin markets, capital will begin flowing out of those markets and into these ignored and relatively cheap markets.
Outside of equities markets, you can look at so-called “safe haven” assets. These are typically assets which are tangible and have long-term track records for maintaining value. These can include treasury bonds, gold, or real estate. Unfortunately, real estate in the United States is less than attractive given that it is weakness in real estate which is hurting the markets. But, that’s not to say that global property is not still a good play. Increased liquidity and wealth around the world has created booms in most property markets and governments around the world are starting to employ REIT structures for real estate companies to spread the wealth. iShares offers several broadbased real estate funds which will allow you to get access to FTSE (Europe) and the World ex-US. It also offers an ETF which tracks the COMEX Gold index (symbol: IAU). Gold is more a diversifier (uncorrelated) than a truly negatively correlated investment but in times of turmoil like a major decline in the markets or a global upheaval, it has historically done very well. Though, as with most things, there are exceptions as gold has not quite performed as a good hedge against the US markets over the last few weeks.
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