Why diversifying risk management is 'key' right now

Yahoo

5 days ago

Vest co-founder and president Jeff Chang joins Market Catalysts with Julie Hyman to discuss investor strategy amid the current bull market, target buffer exchange-traded funds (ETFs), and how to hedge your portfolio against future volatility.
To watch more expert insights and analysis on the latest market action, check out more Market Catalysts here.
We've been having this sort of discussion and debate about the under the surface signs. What do you see?
Yeah. I mean, if you look, like, you know, the stock market's at all time highs and a lot of it is, and if you think about overall risks in the market, right? Like, you see anything from, um, you know, are the AI mega cap stocks overvalued at current PE levels. And you think about a lot of consensus is a lot of the earnings growth associated with AI and the mega caps have already been priced in, right? Are we at that level that we're already there? And then on top of that, you have a lot of other risks that are there. Geopolitical risks, like if you think about, um, you know, Israel, Iran, 20% of the oil comes through the Strait of Hormuz, which borders Iran. Uh, what are those impacts and how does that affect the overall economy? And then tariffs, right? Um, I know a lot of people are largely, the market has has anticipated that there were going to be some resolution. I mean we we'd have seen, uh, you know, kind of like you explained today, the Japan deal that that occurs. That gives a little bit of hope, but that's still fundamental risk in the market and we're at all time highs. So this is where, you know, we've seen a lot of our clients saying that, "Hey, um, what are, where do we position our portfolio at all time highs?" And so a lot of times I say, uh, you know, when is the best time to buy protection or hedge yourself? Is it when the markets are at all time highs or when they've already dropped, let's say a 15, 20% pullback? It's like, it's like buying insurance. You don't buy flood insurance after the flood, right? And this is why we've seen an explosion and a really, uh, increase in interest in like, let's say, buffer type products or hedge type products and investments because of the way the market is shaping up. Because it is kind of the moment in which you actually want to hedge because, um, you know, there is a still a lot of fundamental risk within the within the market.
And so, um, how then does this give them exposure, but try and limit the downside?
So, in most buffer strategies, they, you get exposure to, you know, like, let's say a broader index or any, any type of underlying, but in most cases it would be like, let's say something like S&P. And if it were to pull back, let's say 10, 15%, uh, these strategies would protect, let's say the, uh, the first 15% or first 10%. Um, the reason that is is is that, you know, the most likely drawdowns in the overall broader markets are between, you know, 10 and 15% when you historically look at market drawdowns. Now, um, the way, uh, in exchange for that downside protection, you're giving up some upside. So let's say,
Well, that's what I was going to say. I mean, stocks, these, all of these obstacles that you mentioned, Yep. they've been around now for a few months and the stock market keeps making new records. Yep. So you give up a little bit of that upside if you go, you know, if you put, but you're not, I assume you would not recommend to somebody that they put everything into No, not at all. Yeah, absolutely not. this kind of.
No, not at all. Yeah, absolute, absolutely not. I think what's key here is the ability to, for an investor to diversify their risk management. Because traditionally, when you think about it, you have your traditional 60, 40 portfolio, right? Where the thought process is, "Hey, you know what? Put some of my wealth in stocks and bonds." But here's the challenge right now. Unless you were managing money 40 years ago, you were not managing money during times of inflation. What we saw in 2022 is as interest rates go up, both stocks and bonds fell in 2022, right? You could have mixed your stocks and bonds any way you wanted in 2022, you were down. This caught a lot of people by surprise. So the question then becomes is, what in your portfolio will save you if inflation rears its head again? And if you think about what is the risk of inflation, we're already starting to see some of the trickle effects of tariffs into, you know, the inflation numbers. Uh, and then also what about wage growth? That's been really pushing upwards into inflation numbers. And then like I said, geopolitical risk, right? If, you know, 20% of oil is coming through the Strait of Hormuz, if oil prices and you know, oil goes to 90 a barrel, you're going to see headline numbers, like headline CPI really spike. Then the Fed has to act. And the market, while they baked in, let's say a 75 basis point cut later this year, then that starts to come into question that could really affect equity markets. Not only equities, but also bonds as well. And this is why we think hedging, which has a, the great thing about hedging is it's perfectly negatively correlated to whatever you're hedging as opposed to relying on the negative correlation between stocks and bonds where traditionally, uh, you know, when stocks go down, you have this hope that bonds go up, right? That starts to break down in certain environments, especially when you start to have inflation.
Yes. Well, on the flip side, those things might not have, right? In other words, it looks less likely now than it did a month ago that the Strait of Hormuz is going to be interrupted. And, you know, even if you see inflation, I mean, and then what role does gold play in a portfolio also if you're trying to hedge against inflation?
Yeah. And I would say not just gold, but also like things such as like Bitcoin and so on and so forth. They're all really interesting things. Um, and it's not, not to say it will happen. It's saying that if it does, what do you have in place to defend against that? And that's what's great about, you know, let's say, just even taking buffer strategies as an example. You're still participating in the market, right? That's the thing is that like getting people to stay invested is one of the most important things. And we find that, you know, downside hedging can be a really big benefit to, you know, everyday investors as far as keeping them invested, especially with these types of risks on the horizon and we're at all time highs.
Yes.
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