Futures and options, gold, debt, and even index funds can act as good hedges for investors.
With the stock markets continuing to stay volatile for over a year, investors and even experts have been unable to predict the bottom. In the past year, the Bombay Stock Exchange's Sensitive Index, or Sensex has fallen 16 per cent.
In such circumstances, while investment experts will suggest that one should not look at day to day movements, the continuous erosion in the portfolio’s value can hurt investors. At such times, a good hedge helps contain losses.
But, this will depend on the type of your portfolio. Typically, an equity-oriented portfolio is advised to hedge with gold as, traditionally, both the asset classes are inversely proportional to each other. Though not any more. This year, both asset class were moving together.
No wonder, 32-year old Paritosh Malviya is confused. He has a very high exposure to equity. Today his total portfolio is worth Rs 10 lakh. Of which, Rs 5.5 lakh is in large and midcap stocks. Another Rs 3.5 lakh is in equity mutual funds (large and midcap). Remaining Rs 1 lakh is in bank deposit. Malviya has been invested in equity for four years and banks deposits fetch him around 7 per cent (since 2009).
In his case, certified financial planner Arnav Pandya feels diversification will help Malviya hedge. “He can look at bringing in diversification in the stock holdings to minimise any risks. For instance, he can hold some low beta stocks or defensive sectors like FMCG and Pharma to reduce the impact of market volatility on the portfolio,” adds Pandya.
The other option is to buy index options or selling futures. The best part being that these are liquid options. A futures contract is agreed to be bought at a future date, with the price and terms set today. It protects from the risk of higher prices of the underlying in the coming days. An option is a contract that gives the holder the right to buy / sell a security on or before a date. But, here, the buyer has to pay a premium (fee), 10-25 per cent. And, if your call goes wrong, the difference has to be paid. Suppose the Nifty contract falls to 5,000 points from 5,200. The investor will have to pay Rs 10,000 (200x50).
However, this hedging option may not always help make money. If the index moves up instead, a futures position will incur loss, the investor has to fund it.
| PROTECTING DOWNSIDE RISKS | |||
| Name | Paritosh Malviya | Prabha Singhal | Upendra Sharma |
| Age | 32 | 45 | 55 |
| Profession | Software professional | Supplies diet tiffins | Lawyer |
| Portfolio worth | Rs10 lakh | Rs5 lakh | Rs70 lakh |
| Allocation | Stocks = Rs5.5 lakh | Bank deposits = Rs3 lakh | Real estate = Rs55 lakh |
| Equity MFs = Rs3.5 lakh | Gold = Rs50,000 | Stocks = Rs8.5 lakh | |
| Bank deposits = Rs1 lakh | Savings a/c= Rs1.50 lakh | Ulips = Rs6.5 lakh | |
| Must-have Hedge | Options and futures/debt | Not required | Use rental income to get into debt instruments |
Therefore, adopt this strategy for the short term provided you understand it warns Mukesh Dedhia, director of Ghalla Bhansali Stock Brokers. Of course, he can have some debt as well.
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Bilaspur-based lawyer Upendra Sharma has always invested in real estate as he thinks this asset class always returns the most. More so, if done in smaller cities as he feels metro cities have little headroom in comparison.
“With age, I have sold out most of my holdings. Today, my portfolio is worth only Rs 70 lakh. Of this, I hold two residential properties worth Rs 20 lakh each, excluding the one I stay in. And one commercial space worth Rs 15 lakh,” Sharma says. He has stocks worth Rs 8.5 lakh and Rs 6.5 lakh in investment-cum-insurance products.
Real estate investments are difficult to liquidate. So, it is prudent he reduces his exposure gradually and use the proceeds to buy liquid instruments.
Lovaii Navlakhi of International Money Matters suggests Sharma book profits on stock investments on any marginal rally. And the rental income, if any, can be divided between equity and debt, given his age.
Diet tiffin supplier, Prabha Singhal, has always invested in debt and gold. Ninety per cent of her Rs 5 lakh portfolio is invested in fixed deposit and savings account. Near the peak of interest rate cycle, experts say, she should stays put as she does not want to take any risk.