Investment products can hedge against market volatility

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.

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 a 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 USD1519 an ounce (AUD2267) so $100,000 would buy him 46 ounces. The AUD was then worth USD0.67.

Option Three is to try one of the relatively new hedging products, such as Beta Shares Australian Equities Strong Bear Hedge Fund, ASX code 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 per cent, BBOZ should fall 10 per cent. 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 February 21 and then plunged to 4564 on March 23. The price of gold also fell - it went to US$1477, but our investor still did well. Because the Australian dollar had depreciated to US$0.58, his gold was worth AU$117,100. This is the benefit of owning assets in American 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.

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.

My stockbroker tells me there are now other products available, with more being developed. The other ones available now, both listed on the ASX, have the codes BEAR and BBUS. The first one moves similarly to BBOZ, except its performance up or down matches the All Ords. BBUS tracks the entire American market, so it may be a reasonable punt for those who think the American market will go through turbulent times as the election in November gets nearer.

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. noel@noelwhittaker.com.au
This story Investment products to consider amidst market volatility first appeared on The Canberra Times.