Welcome to the Hedging Party!
By Derek Moore
It has been refreshing lately to turn on the various financial news outlets to find guests speaking about portfolio hedging. Of course this is nothing new for ZEGA. Our core portfolios are built around and always hedged or buffered concepts.
Markets often climb what many experts call a wall of worry. This is where you’ll here a laundry list of everything that could cause a market selloff. Currently, the worry is the Federal Reserve and the upcoming rate decision. It seems like something other than at least a 25 basis fed funds rate cut would be perceived as bad for markets.
Then we have markets at all-time highs. Jay Pestrichelli and I recorded a whole podcast recently where Jay pointed out that around 36% of the time the market is within 3% of an all-time high. Does this mean people are fearful over a 1/3rd of the time? Seems like hedging would subside those fears people have about their portfolios quite a bit of each year.
The reality of hedging is that the cost to build portfolio insurance is lowest when markets are moving higher. We all have seen when markets suffer serious selloffs, the price of hedging or insurance moves up precipitously.
As we monitor the markets and watch CNBC, we see more mentions of utilizing downside hedges where managers are willing to give up a percentage of the upside for the value of protecting against large downdrafts. Below you can see a recent guest talking about this very thing.
The markets will likely react badly to Fed rate decision, strategist says from CNBC.
In the clip Kathryn Rooney Vera talks about using the December puts that have a cost of hedging of 3.5%. The reasoning was based, from the interview, on the view that the market is pricing in too much of a rate cut expectation.
Firms with medium term worries would do well to take on a little insurance. Especially when its less expensive. While I enjoy conversations about markets, an always hedged strategy like ours also takes away the need to directionally predict markets.
Regardless, this week’s Fed decision and the press conference afterwards should be quite interesting.