Advantages of protecting a portfolio

As you approach retirement it's prudent that you consider reducing your exposure to risk assets. While shares pay great dividends which can be used to fund retirement, the exposure to volatile assets can be undesirable.
The advantage of protecting a portfolio vs investing in cash or bonds to reduce risk, is the portfolio continues to receive franking credits and dividends whilst benefiting from share price appreciation, but can help avoid large market corrections as experienced in the GFC.

Typical investors using protection

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Retiree
Investors

Retirees are typically less tolerant of volatility and are forced into lower risk assets. By protecting part or all of the portfolio, retirees can reduce risk in their portfolio.

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Leveraged
Investors

When borrowing to invest, the cost of a correction can be amplified. The ability to hedge out corrections can make the prospect of leverage more attractive.

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Conservative
Investors

Conservative investors who may typically avoid shares as an asset class can use protection in an attempt to reduce the risk on a portfolio and allow them to invest with an increased level of comfort.

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Proactive
Investors

Any investor who has a proactive interest in their wealth and is not satisfied being at the mercy of predictable market movements.

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Why wouldn't I just sell my shares if
I'm worried about the market falling?

Investors may consider simply selling down their equities exposure if they foresee a market correction on the horizon. Using cash as a hedge can be a great way to mitigate risk. However that approach does have some limitations which need to be considered.

Incorrect View

No one gets direction right all the time. If you are wrong about a fall and sell your shares you miss out on upside.

Capital Gains Implications

Many investors who have a long term portfolio spanning decades can potentially have significant capital gains implications when selling a holding.

Transaction Costs

Transaction costs on large parcels of shares can make the decision to sell out of a holding unfeasible.

Missed Dividends

Selling a holding over a dividend period will mean you miss out on the dividend payment.

Speak to an adviser about how to implement protection in your portfolio today.

How we protect portfolios

There are a number of ways to protect a portfolio and various degrees of protection. We generally use S&P/ASX200 index options as they can be closely correlated to a portfolio of ASX shares and therefore reduce transaction costs. Depending on the strategy, costs can range from free through to a percent or two of the overall portfolio value.

  • Our Science

    Our approach to protection is based on several underlying indicators that allow us to identify potential periods of market weakness. After a decision is made to protect portfolios, the analyst team will attempt to predict the severity and duration of the fall, then formulate an options strategy to mitigate the potential loss.

  • Low-to-Nil Cost

    Often we identify unique opportunities to establish partial protection on portfolios for almost no cost. Your adviser will be able to identify and alert you of these opportunities when available.

  • Duration

    The ideal time frame is around 2 months, however for smaller portfolios protection may be purchased over longer periods to reduce the number of transactions.

  • Implementation

    An adviser will be able to handle the process from identifying opportunities, implementation and ongoing management.

Using put options to protect a portfolio

How we predict volatility

Volatility Index (XVI.ASX)

The S&P/ASX200 VIX Index is a measure of market volatility. It uses index option pricing to determine equity market volatility. In times of extreme fear, the VIX will spike to high levels as investors buy puts and push option prices higher.

Market P/E Ratio

The Market Price to Earnings Ratio tells us the price of shares verse current earnings. It tells investors if shares are cheap or expensive relative to their earnings. The ASX 200 has traded around 14-15 for almost 50 years, making higher levels expensive and lower levels cheap.

Market Dividend Yield

The ASX200 dividend yield is simply the percentage dividend return of the top 200 ASX stocks. It tells investors how much income they will be paid for owning these shares. When shares are cheap, investors are generally paid a higher dividend and a lower dividend when they are expensive.

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Fear & Greed Indicator

The indicators above come together to produce what we refer to as the "Fear & Greed Indicator". In a general sense, this tells investors the value and sentiment of the ASX200 and can be used to determine when it is appropriate to hedge out portfolio risks or take on more exposure.

What are the risks?

Market Risk

We use options to hedge market risk of your share portfolio. Note that the Options may fall in value or become worthless. Changes in the underlying share price may change the Option price, but the option price change may be in a different direction or magnitude.

Time decay

Options have an expiry date and therefore a limited life. An Option's time value erodes over its life and this accelerates as an Option nears expiry which can be beneficial or negative depending on the strategy.

Leverage

Leverage can lead to large losses as well as large gains. When investing in options, your initial outlay is small relative to the total contract exposure, a small market movement may have a larger impact on its value.

Option writers may face losses

Selling Options involves risk. If you sell and the position moves against you, you may lose more than any premium received. Where the position is naked, losses are potentially unlimited.

Calls for additional capital

If the market moves against you or margins increase you may have to provide additional funds at short notice. If you do not, your position may be closed and you will be liable for any resulting loss.

Speak to an adviser about how to implement protection in your portfolio today.