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Protecting Your Wealth From Inflation & Investment Losses
Professionally Managed Hedging Strategies
Without Using A Hedge Fund
Hedging Benefits Without The Hedge Fund Fees
Since hedging strategies are often misunderstood by investors and seen as "risky", three points are covered in this section in an attempt to better clarify how hedging is used in the CCM Portfolio Management Strategy.
- As shown in Figure 27, hedging a stock portfolio in unfavorable conditions can significantly improve performance
- Professionally managed funds that use hedging strategies are available to individual investors and personal money managers. It is not necessary to pay high hedge fund fees to add hedging strategies to a well diversified portfolio.
- A "long-short" hedging strategy is significantly different and less volatile than a pure "short" strategy.
The CCM Portfolio Management Strategy does incorporate a U.S. stock investment that, under unfavorable market conditions, uses options and futures contracts as "insurance" to hedge against declining stock prices. In this way, our professionally managed hedging strategy is very similar to a "long-short" hedge fund. The CCM Model Contraction Portfolio can have as much as 25% of the portfolio hedged based on the models used by the manager who operates the hedging strategy. The CCM Model Expansion Portfolio can have as much as 7% of the portfolio hedged based on the models used by the hedge manager.
The fees to implement this hedging strategy used in the CCM Model Portfolios are similar to those of a standard mutual fund. As hedge fund investors know, a typical hedge fund charges a 2.0% annual fee and they also keep 20% of the profits made. The hedged investment that we use in the CCM Portfolio Management Strategy has an annual operating expense (as of July 1, 2006) of only 1.10% vs. 2.0% for a typical hedge fund. The hedging strategy we use does not charge the typical hedge fund performance fee (20% of the profits). To illustrate hypothetically how significant high hedge fund fees are in reducing investor returns, Figure 28 below shows the returns of the hedging strategy used in the CCM Portfolio Management Strategy vs. the same returns with a typical 20% hedge fund performance fee.
"Naked" shorting or shorting without also owning long positions to offset the short positions is a much more uncertain and volatile strategy. The CCM Portfolio Management Strategy uses only long-short hedging strategies and does not rely on short-only strategies. An example of a short-only strategy is the Rydex Inverse S&P 500 Fund, which attempts to produce returns that are inversely related to the return of the S&P 500 index. To illustrate the difference in volatility between long-short and short-only hedging strategies, Figure 29 compares the long-short strategy used in the CCM Model Portfolios (long-short) to the Rydex Inverse S&P 500 Fund (short only). A well managed long-short strategy can offer less volatility than a non-hedged investment such as the S&P 500 Index or Vanguard 500 Index.
Testing Your Current Portfolio For Possible Correlation Risk
Here is a quick test that you can run on your own investment portfolio to see how well diversified you really are � the results might surprise you. Using the "total return" page on www.morningstar.com and the historical prices feature on Yahoo! Finance, find out how each of your investments performed in the years 2000, 2001, and 2002. If you want to get the best numbers possible, use the historical prices function on Yahoo! Finance to see how each investment performed from Aug 25, 2000 to October 7, 2002, which represents the roughest period of the last bear market in stocks. Assuming you reinvest your dividends, use the adjusted price in Yahoo! historical prices.
Summary of CCM Portfolio Management Strategy
An investment portfolio, which is well constructed using a wide variety of asset classes, can produce positive returns under both favorable and unfavorable market conditions without relying on expert timing or accurate economic forecasts from a portfolio manager.
A portfolio manager's allocation decisions, which are based on the manager's economic outlook, and the timing of those decisions, can add meaningful incremental improvement to an investment portfolio's returns. However, the most important factor in producing consistent positive portfolio returns, under conditions that are both favorable and unfavorable to U.S. stock investors, is the inclusion of the following wide range of investment classes in a diversified portfolio:
- U.S. stocks (married with hedging strategies discussed on page 3)
- U.S. bonds (varied durations)
- Physical commodities (such as oil, wheat, corn, etc.)
- Commodity stocks (energy, base metals, etc.)
- Physical gold & silver
- Gold stocks
- U.S. commercial real estate
- Foreign commercial real estate
- Foreign bonds
- U.S. dividend-paying stocks
Within the study parameters, positive outcomes vs. the S&P 500 Index were produced under various assumptions. The common element among all the positive outcomes was the inclusion of the asset classes above in a diversified portfolio of investments.
The study period (shown in Figure 1 above) is referred to as a full market cycle since it includes both a bear and bull market in U.S. stocks. Even under very conservative assumptions where the portfolio manager makes significant mistakes within the strategy's framework, the widely diversified portfolio of investments was able to produce positive returns and outperform the S&P 500.
The limitations of the study, such as only reviewing one market cycle (2000-2006), and the real world application of the CCM Portfolio Management Strategy are discussed on page 2. You can review the limitations and common sense adjustments that must be made by clicking here.
2008: Information about managing multiple asset class investment portfolios can be found in Multiple Asset Class Investing:
Strategies for Inflation, a Weak U.S. Dollar,
and Principal Protection
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Chris Ciovacco is the Chief Investment Officer for Ciovacco Capital Management, LLC. More on the web at www.ciovaccocapital.com