Thursday, August 11, 2011

Trim the Hedges?

At the moment we have concluded as a firm that the higher probability is that we are in a new bear market rather than a severe correction like we witnessed last year. Therefore we have been busily crafting and re-crafting strategies to deal with this hostile period for the market. Luckily we have some hedges in the portfolio that are providing the exact inverse qualities to the stock market that we expected from them. Specifically, gold and long-term Treasury bonds have been our most productive hedges during the latest sell-off, and we have definitely been rewarded for holding these positions in our portfolios to date.

But looking backwards at performance is always dangerous. Both of these assets are very volatile, and contain their own risks. So as we’ve been setting stops and removing equity risk in portfolios, we are faced with a decision as to whether we should trim our hedges and lock in some gigantic gains in the process. On the one hand it is very tempting to take the latest run up in gold or long maturity bonds and sell them to cash right here. It seems like you can’t lose with a huge win booked, right? The downside would be if the bear market intensifies, and we now have less of these hedges to help defend in our portfolios. It’s a tough choice, and one I’ll be mulling over so I can give the investment team a definitive answer in the very near future.